The Daily Update - Slovenia upgraded...but still expensive

Last week, Moody’s surprisingly upgraded Slovenia's rating by two notches, from Baa3 to Baa1. The rating agency cited the key drivers as: a ‘favourable debt trend, driven by fiscal consolidation and robust economic growth’ and ongoing progress with ‘structural reforms...with regard to the banking sector, judiciary and the administrative apparatus of the state.’

Rating agencies are clearly split on the rating for Slovenia, with S&P rating the country’s long-term rating at A+ (upgraded one notch in June, and three notches above Moody’s) and Fitch assigns Slovenia an A- rating. The country’s fundamentals have certainly improved since it was rated junk (by Moody’s) back in 2013; the rating agency estimates Slovenia’s nominal budget deficit at 0.8% of GDP this year and its debt burden below 75% of GDP in 2018, with the current account surplus sitting above 5% of GDP. We assign Slovenia a 4 star NFA ranking, up from 3 stars back in 2014; so the country’s investment grade bonds fit into our universe.

However, we do not hold Slovenian bonds across our global bond funds as they are not as attractive as one would assume. The euro benchmark curve trades at a negative yield up to 7 years, and the 10-year yield is currently below 1%, while the 30-year sovereign trades at only ~2.07%. In fact the 30-year bond trades at a spread of only ~95bps above the Bund curve, despite being rated 4 notches lower (on a best rating basis) than AAA rated Germany. If we use the bond’s best rating of A+, we calculate that the 3.125% 2045 bond is still expensive; similarly rated bonds trade at ~115bps over Bunds. Slovenia’s USD sovereign paper also trades expensively, an example could be the 5.25% 2024 bond, which trades at a spread of 60bps, while similar bonds are around 70bps over USTs.

We also don't own any euro denominated bonds as US dollar paper trades relatively wider currently.  We could make a comparison using one of our favoured issuers, Chile’s state-owned Codelco. The A1 rated 2.75% 2024 euro issue offers a yield and return of 5.60%, while the USD 2.4% 2025 bond we hold has an expected return and yield of 6.5%.

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