MGS sell-off gathers momentum

Article #477 by Edward Rizzo - Published Published Articles

Just over three months ago I wrote an article titled “The MGS market after Trump” wherein I gave a detailed description of the sudden drop in the prices of Malta Government Stocks (MGS) in the immediate aftermath of the result of the US election on 9 November.

I had also published a table showing the decline in MGS prices from their all-time highs reached between the end of October and early November 2016 and the prices at the time of publication on 22 November 2016. The table depicted a decline of between 471 basis points and 941 basis points within the space of just over 3 weeks for MGS’s maturing in 2028 onwards.

Since then, although yields across the Eurozone (and hence prices across sovereign bond markets including MGS) remained particularly volatile from one week to the next, the overall downward trend across the bond market persisted. In fact, the Rizzo Farrugia MGS Index edged up by 0.45% in December 2016 but then slumped by 2.91% in January 2017. Eurozone yields eased lower during the month of February and as a result, the RF MGS Index partially recovered from the steep losses in January as it rose by 1.07%.

However, last week, the RF MGS Index plunged again, this time by 1.42% (its worst weekly performance in nine weeks) to 1,110.593 points – its lowest level in over two years. Last Friday, the indicative bid price quoted by the Central Bank of Malta for the longest-dated stock in issue (the 2.40% MGS 2041) reached a new all-time low of 96.40% compared to its all-time high of 111.27% only three months ago. Likewise, the indicative prices for two of the longer-dated MGS’s issued last year – the 2.5% 2036 which was issued in February 2016 at a price of 101.50% and the 2.10% 2039 which was issued in October 2016 at 102.50% – also fell to record lows of 100.68% and 93.26% respectively. Furthermore, the most recently issued longer-dated MGS (the 2.20% 2035) fell to 98.61%, representing a drop of 164 basis points from the issue price of 100.25% only a few weeks ago.

The extent of the decline in the MGS market may be depicted by the fact that in less than five months, all MGS prices with maturities of nine years and over, are now more than 10 percentage points below their respective prices on 24 October 2016 – the day when the RF MGS Index reached an all-time high of 1,182.272 points.

So what is the main cause behind this renewed sell-off last week?

The main reason for the decline in MGS prices was the market reaction to the European Central Bank’s (ECB) Governing Council meeting held last Thursday during which the ECB left interest rates on hold at record lows but increased its growth and inflation forecasts for this year and next. The ECB is now expecting GDP growth of 1.8% this year and 1.7% in 2018 from the previous forecast of +1.7% and +1.6% respectively. Likewise, the ECB sounded more upbeat in its inflationary forecasts as it is now anticipating an inflation rate of +1.7% this year and +1.6% in 2018 compared to last December’s forecasts of +1.3% and +1.5% respectively.

During the customary press conference following the conclusion of the ECB Governing Council meeting, President Mario Draghi said the ECB no longer had a “sense of urgency” to take further action on monetary stimulus. Mr Draghi also removed a key sentence from the customary ECB statement, that “The ECB will use all instruments available to bring back inflation”. He also stated that policymakers “do not anticipate that it will be necessary to lower rates further”.

The ECB effetively sent a positive message to the market about the results of the monetary policy programme as eurozone inflation rose above its target of just under 2 per cent for the first time in four years. Mr Draghi basically declared victory over the deflation risks that had prompted the ECB to commence its bond-buying programme in the first quarter of 2015 in order to drive down borrowing costs across the eurozone as a way of stimulating the economy.

Financial analysts and commentators interpreted these remarks as a sign that the ECB was preparing to pare back further its bond-buying programme. As from next month, the bond-buying programme is being reduced to €60 billion per month until December 2017 from the current level of €80 billion per month.

The subtle shift in the message from the President of the European Central Bank led to a rally in Germany’s 10-year bond yield on Thursday afternoon to 0.43 per cent from just 0.18 per cent 10 days earlier.

German bund yields continued to rally the following day in the aftermath of the ECB press conference and also after a report published on Bloomberg indicated that the European Central Bank had discussed whether rates could rise before it completed its bond buying programme scheduled for December 2017. Currently, banks are being charged 0.4 per cent on a portion of reserves parked at central banks across the eurozone. An easing of this negative rate would be positive for the banking sector as the negative deposit rate is squeezing profit margins since banks cannot pass this cost back to their customers.

The report from Bloomberg also said that members of the ECB’s Governing Council had discussed ways how to normalise monetary policy measures and an effective manner of how this plan should be communicated to the market.

Should the ECB truly raise rates before the end of the QE programme, it would mark a departure from the guidance on timing of rate hikes that the President of the ECB has given since March 2016, when he lowered the deposit rate to minus 0.4 percent. The President of the ECB had repeatedly claimed that “The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases.”

This method would also differ from that adopted by the US Federal Reserve which ended its QE programme in October 2014 and raised interest rates for the first time in December 2015.

Although during last week’s press conference the ECB President played down the prospects of a rate hike before the end of its QE programme, he noted that the “probability of a rate cut has gone down”.

Some international economists are now anticipating that the ECB will lift the eurozone deposit rate by 25 basis points from a record low of minus 0.4 per cent as early as September 2017 and continue winding down its bond buying programme in early 2018.

In the coming months, should economic data continue to confirm the renewed positive momentum across the eurozone region and the ECB truly moves towards such tightening policies, yields are widely anticipated to continue to edge higher towards more normalised levels.

It is worth highlighting that prior to the start of the QE programme in early 2015, the eurozone 10-year benchmark bond yield stood well above 1% during the first half of 2014 and only dropped below 0.5% at the start of 2015 once the ECB formally announced a commencement date for QE purchases. Should yields edge up past the 1% level once again, sovereign bond prices across the Eurozone will continue to decline and MGS prices will follow such a trend.

As such, retail investors who may have purchased MGS’s mainly for speculative purposes and have not yet been able to exit their positions should take note of such a possibility. Bond yields and MGS prices will undoubtedly remain very volatile from one day to the next mainly influenced by economic data, statements by officials of the ECB, political developments and other factors. Investors would do well to understand the current climate and the implications should conditions across the Eurozone continue to improve.

  Print This Page

The article contains public information only and is published solely for informational purposes. It should not be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. No representation or warranty, either expressed or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in this article. Rizzo, Farrugia & Co. (Stockbrokers) Ltd (“Rizzo Farrugia”) is under no obligation to update or keep current the information contained herein. Since the buying and selling of securities by any person is dependent on that person’s financial situation and an assessment of the suitability and appropriateness of the proposed transaction, no person should act upon any recommendation in this article without first obtaining investment advice. Rizzo Farrugia, its directors, the author of this article, other employees or clients may have or have had interests in the securities referred to herein and may at any time make purchases and/or sales in them as principal or agent. Furthermore, Rizzo Farrugia may have or have had a relationship with or may provide or has provided other services of a corporate nature to companies herein mentioned. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security mentioned in this article. Neither Rizzo Farrugia, nor any of its directors or employees accepts any liability for any loss or damage arising out of the use of all or any part of this article. Additional information can be made available upon request from Rizzo, Farrugia & Co. (Stockbrokers) Ltd., Airways House, Fourth Floor, High Street, Sliema SLM 1551. Telephone: +356 2258 3000; Email: info@rizzofarrugia.com; Website: www.rizzofarrugia.com © 2021 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved. This article may not be reproduced or redistributed, in whole or in part, without the written permission of Rizzo Farrugia. Moreover, Rizzo Farrugia accepts no liability whatsoever for the actions of third parties in this respect.

This article was produced by Edward Rizzo, Director at Rizzo Farrugia, which is a company licensed to undertake investment services in Malta by the MFSA under the Investment Services Act, Cap. 370 of the Laws of Malta and a member of the Malta Stock Exchange. The company’s registered address is at Airways House, Fourth Floor, High Street, Sliema SLM 1551, Malta.