Bonds: Periphery debt gains despite fall of Lisbon government

UK: 2.03% (-1bp)

US: 2.32% (-3bp)

France: 0.95% (-4bp)

Germany: 0.62% (-4bp)

Spain: 1.87% (-9bp)

Italy: 1.69% (-6bp)

Greece: 7.65% (-7bp)

Portugal: 2.77% (-6bp)

Japan: 0.32% (-2bp)

Gilts were little changed on Tuesday against a backdrop of sharp gains in the rest of Europe after European Central Bank governing council member Erkki Liikanen said he saw downside risks to the inflation and growth outlook in the single currency area.

Nonetheless, some market commentary took note of how the UK 10-year break-even inflation rate rose to 2.53%, a seven-week high, in tandem with increased speculation of an interest rate hike by the US Federal Reserve.

That came after the Debt Management Office auctioned £700m of inflation-linked debt maturing in 2058 at a yield of -0.76%.

Spanish bonds outperformed, recovering from the previous day’s losses after the regional parliament of Catalonia voted to start a secessionist process.

On Tuesday, the centre-right government in Lisbon lost a no-confidence vote, which analysts expected would force new elections next year – it won the 4 October elections by a slim majority.

For some observers, the news marked the re-emergence of political risk on the Iberian peninsula.

“Developments in Portugal confirm that Syriza’s failure has not stopped the anti-austerity movement elsewhere. The Spanish election next month could bring further evidence of this, perhaps ultimately forcing the European authorities to choose between loosening the fiscal reins or running the risk of countries leaving the euro-zone to escape more damaging austerity,” Capital Economics’s Jennifer McKeown said in a research report sent to clients.

On Monday, the risk-premium on the Lisbon government's debt hit a four-month high at 222 basis points.

For the short-term at least, Alberto Gallo, head of Macro Credit Strategy at RBS, said his outlook for Europe continued to be “tactically positive” but only because of the continued support of the ECB through its QE programme, with more expected in December.

However, come 2016 the economy would be back in the hands of politicians.

“With supportive ECB policy, European credit looks better relative to US and EM. We prefer niches in short supply, including bank subordinated debt (LT2, selective Cocos), selective corporate hybrids (short-dated), triple-B bonds in IG and double-Bs in high yield, and periphery (preference for Spain on Catalan headline risk, but also long Italy).

“We recommend staying underweight European names with strong EM exposure including Standard Chartered, Santander, HSBC and UniCredit,” Gallo said in a research note sent to clients.