Markets warming to Greece
Feb 17 2010 By Andrew Miller, The Journal
EUROPEAN government debt markets have had a rough time of late; fears about Greece’s financial health and worries that "contagion" could spread to other economies such as Portugal, Ireland, Greece and Spain have both played their part in the recent volatility.
But, towards the end of last week, European bond markets seemed to stabilise on hopes that some sort of solution for Greece’s travails would be forthcoming. So, is the crisis in European bond markets now over?
Largely the answer to that question depends on developments in Greece which in turn would seem to hinge on the outcome of Greece’s talks with the European Union. Here, opinion already seems to be polarising.
At the less positive end of the debate, the Lower House of the German Parliament has already come to the conclusion that the Maastricht Treaty implies a no bail-out clause, as one euro-area country cannot assume or guarantee the debt of another.
The Bundestag therefore does not envisage any direct financing of the Greek budget by the European Central Bank or indeed by any of the other national European central banks. More positively however, the EU president announced an agreement to take "co-ordinated action" to support Greece if the government implements all the austerity measures, including the reduction of the budget deficit by 4% in 2010.
The markets appear to have taken these developments favourably, as the euro seems to have stabilised and the difference in yield between Greek bonds and German bonds of the same maturity compressed sharply last week.
We have been positive on the likelihood of Greek government bonds rallying relative to German government bonds (the latter being the safe haven in European bond markets) on the back of hopes of some form of EU-backed assistance for Greece.
However we believe that the lack of a clearly defined rescue plan could create renewed volatility. In any case short-term Greek Treasury Bill yields are no longer as attractive as they were.
As a result, Greek bonds are now no longer quite so appealing to risk-hungry investors.
Overall, we continue to think that investors should favour short-term government debt over long-dated government debt as we expect upward pressure on government bond yields from a number of sources, including pending supply, weaker demand, as well as an increase in professional investors’ risk appetite.
All of these trends are unhelpful for government bond prices, particularly longer-dated bonds.
In addition to all of this, government debt is by no means cheap by historical standards, so valuations remain vulnerable in the longer term if signs of global economic recovery continue to build, irrespective of what happens in Greece over the next few weeks.
Andrew Miller is head of Barclays Wealth office in Newcastle
