Few investors may have noticed the extent of the rally in Malta Government Stock prices over the past three months. Since most local investors have substantial exposures to Malta Government Stocks (especially those of a longer term nature due to the numerous such issues in recent years), the rally positively impacted investment portfolio valuations of individuals and companies holding such securities.

Some observers may rightly question the reason for the sudden sharp upward movement in MGS prices. In recent years, prices and yields of MGS moved very much in line with the eurozone benchmark, which is the German bund.

The initial jump in prices took place in early June when the European Central Bank announced a 10 basis point rate cut in official interest rates to 0.15 per cent. The previous interest rate movement occurred in November 2013 when the ECB reduced interest rates by 25 basis points from 0.50 per cent to 0.25 per cent. At the same monetary policy meeting in June, the ECB had also decided to reduce the deposit facility interest rate to -0.1 per cent in a bid to spur an economic recovery and avert deflation. Effectively, this implied that banks had to start paying interest to deposit money at the ECB.

This was the first time that a major central bank adopted a negative interest rate. Although the rate cut was widely expected at the time, eurozone yields immediately declined (and prices subsequently increa­sed) with MGS prices and yields also moving in a similar fashion.

Data from the eurozone in the following weeks continued to support the decision by the ECB and led to a further decline in yields as statistics from various countries indicated a weakening economic outlook including the all-important German economy. The rate of inflation across the eurozone also continued to decline and coupled with this, the escalating conflicts in Iran, Ukraine and other regions including North Africa supported a ‘flight to safety’.

The worsening economic situation across the eurozone led to consistent calls by various economists and organisations for the ECB to adopt quantitative easing similar to the UK and the US. Increased speculation on the extent and the timing of such action by the ECB led to a further sharp decline in yields on eurozone bonds in August. The reference 10-year German bund yield slumped to an all-time low of 0.868 per cent per annum on August 28 compared to a level of 1.40 per cent in early June.

At the September monetary policy meeting, the ECB surprised the markets and announced a further reduction in its main reference rate to a new record-low of 0.05 per cent. The president of the ECB, Mario Draghi, also announced a purchasing programme of asset-backed securities (a tool referred to as quantitative easing) which will commence next month.

Mr Draghi did not disclose the absolute amount of the programme but emphasised that it will have a significant impact on the balance sheet of the ECB.

Benchmark 10-year yields in Europe rebounded towards the one per cent level shortly after the ECB announcement in September as investor sentiment recovered following various media reports revealing that Ukraine and Russia were close to reaching a peace deal. Since then, yields continued to recover and approached a level of 1.10 per cent in contrast to the sharp decline in July and August before dropping back to 1one per cent earlier this week.

Investors who regularly follow the MGS market may therefore be surprised that despite the recovery in eurozone yields, MGS prices continued to rally. As an example, the price of the latest 4.1 per cent MGS 2034 surged to a fresh high of 107.50 per cent last week. This may be somewhat confusing given the trend over recent years when movements in MGS prices and yields very much reflected similar movements in the eurozone.

One plausible reason for the reduced yield gap over recent days between local and eurozone yields is the announcement by the international rating agency Fitch to maintain Malta’s credit rating at ‘A’ with a stable outlook as GDP growth in Malta is outperforming the eurozone average.

What is also worth noting is the consistent demand by various institutional investors for long-term MGS despite the decline in yields over recent months. The significant decrease in yields is evident from the table showing the decline of over 70 basis points (0.7 percentage points) in only five months. The continued strong support for MGS may be due to the fact that only a small amount is still left to be issued by the Treasury this year. During the 2014 budget presented to Parliament on November 4, 2013, it had been agreed that the total MGS issuance for 2014 must not exceed €650 million. Following the various issues that took place between February and July, this would result in a maximum issuance of a further €75 million in MGS by the end of the year. This is a small amount compared to the demand seen at each issue this year.

Corporate bond prices have also increased in recent months

Corporate bond prices have also increased in recent months but to a much lesser extent than the sovereign bonds as indicated in the table with a rise of 10 percentage points in the 2030 and 2031 issues.

Meanwhile, the six per cent AX Investments plc 2024 bonds issued at the start of the year rallied to 106 per cent and the six per cent Island Hotels Group Holdings plc 2024 bonds touched a high of 107 per cent. Given the wider increase in MGS prices, the yield differential between corporate bonds and MGS has also widened in some cases, implying a higher compensation to investors for the higher risk and weaker liquidity in the market attached to corporate bonds.

New corporate bond issuance in the final quarter of the year is expected to be less than that in the first half of the year. The MSE issued an indicative calendar in July on the expected issuance in the coming months. Although no further confirmations/updates have been received since, at least two bond issues are widely expected in October and November. The search for fixed interest paper by retail and institutional investors will therefore intensify as a result of the added supply of investible funds from the redemptions of Melita Capital plc (€25.9 million) and PAVI Shopping Complex plx (€9.5 million) in the coming weeks and the likelihood of a relatively small amount of new Malta Government Stocks on offer.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd (RFC) is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen.

Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

© 2014 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.

Edward Rizzo is a director at Rizzo Farrugia & Co. (Stockbrokers) Ltd.

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