According to ING IM, the rally in peripheral bond and equity markets has not come to an end, as the fundamental picture is still sound. Yet, the recent rise in volatility and the increased short-term risks have made the asset manager decide to close their overweight positions in both bonds and equities of Eurozone peripherals.
One of the consequences of the risen interest of investors in the peripheral markets is that it has become a “crowded trade”. Investor positioning and in particular the concentration of active exposures have been very dominant drivers of market dynamics this year. The recent volatility in peripheral markets seems to be the latest reflection of the sensitivity of "consensus" trades for position squaring on the back of sudden mood swings over the direction of policy or politics.
Rally in Spanish and Italian markets since July 2012
Peripheral markets have rallied since July 2012
Both bond and equity markets of peripheral Eurozone countries like Spain and Italy have been enjoying a strong rally, effectively since ECB President Mario Draghi held his famous “whatever it takes to save the euro” speech on July 26, 2012. The ongoing rally resulted in declining risk premiums and increasing investment flows towards these countries’ markets, as investors increasingly perceived the systemic risks surrounding the Eurozone to be fading, while at the same time economic data started to improve.
In the past months, the anticipation of additional stimulus provided by the ECB and upgrades of credit ratings by the rating agencies also led to a further tightening of credit spreads. The intensification of the search for yield by investors, combined with stretched valuations in other fixed income asset classes (like investment grade and high yield credits), have also contributed to the decline in risk premiums.
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