Greek bonds were the top performers in Europe last quarter, gaining for the first time since the sovereign debt crisis began, as investors bet that record high yields more than compensate for the possibility of a default.
Investors made money on Greek bonds for the first time since the third quarter of 2009, garnering a total return of 3.9 percent in the three months ended Sept. 29, indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies show. The yield premium for 10-year Greek bonds was 818 basis points more than Germany, the most of any euro nation.
“The selling has stopped, and with yields at these levels, that’s all you need to make a good return,” said Padhraic Garvey, head of developed markets debt strategy at ING Groep NV in Amsterdam. “The outlook for Greece hasn’t materially changed, but Greek bonds offer great returns if investors are prepared to hold on for a reasonable period of time.”
Greek markets have been battered since the end of last year when the newly-elected Pasok government said the budget deficit was twice as big as the previous administration indicated. The disclosure forced Greece to tap a 110 billion-euro ($150 billion) loan facility in April from the European Union and International Monetary Fund after being shut out of the debt market.
Finance Minister George Papaconstantinou has until Oct. 4 to draft a budget that convinces investors he can resume borrowing in the bond market. He said as recently as Sept. 9 that he’s reconsidering a plan to increase sales taxes next year because it may hinder growth.
The budget deficit shrank 32 percent in the first eight months of 2010 as the government cut expenses such as wages and pensions to counter the effects of tax evasion, an inefficient tax collection process and a shrinking economy.
The deficit-reduction program “hinges critically on improving tax compliance,” the IMF said on Sept. 14. Greek revenue from taxes is among the lowest in the EU at 32.6 percent of gross domestic product, compared with an average 39.3 percent in the EU-27, according to a 2009 Eurostat report.
“If Greece succeeds in reaching deficit targets in 2011, it could mean a smooth return to the primary markets for funding,” said Ioannis Sokos, an interest-rate strategist at BNP Paribas SA in London. “Clearly, tax revenue collection will be the key.”
Credit-default swaps on Greece were the best-performing sovereign debt insurance contracts in the world this month among developed economies, according to data provider CMA. Swaps for the nation also fell by the most among peers in the third quarter. During the same periods, derivatives for Ireland and Portugal increased by the most in the world, CMA prices show.
Swaps on Greece remain the second-most expensive in the world after Venezuela at 772 basis points.
HSBC Holdings Plc, Europe’s largest bank by market value, Goldman Sachs Group Inc., ING and Societe Generale SA are advising clients to purchase securities sold by Greece.
Goldman Sachs and HSBC recommend Greek 30-year bonds with prices just above 50 percent of face value. Societe Generale advises buying three-year Greek notes, betting a rally in two- year debt will extend to longer-dated securities.
Norway’s $450 billion sovereign-wealth fund, the world’s second biggest, has purchased Greek securities.
Investors should buy two-year Greek notes and hold them for nine months as the higher yield should allow them to outperform equivalent German government notes, even if the spread widens by as much as 320 basis points, ING’s Garvey said on Sept. 27.
Purchasing Greek bonds remains difficult because of the difference in price between buying and selling them, known as the bid-ask spread. Citigroup Inc. was offering to buy 10-year Greek bonds at a yield of 10.89 percent yesterday and sell them at 9.99 percent, meaning the yield would have to fall 90 basis points for the purchaser to break-even on the trade before coupon payments, according to data compiled by Bloomberg.
“It’s a high-risk trade,” Garvey said. “The bid-ask spread means you can’t get in today and out tomorrow unless there’s been a decent move, and the volatility means you could be forced to mark to market in the short term and take a loss.”
Papaconstantinou said last week during a speech in Berlin that Greek risk is “massively overpriced” as investors remain skeptical about plans to reduce the deficit to 8.1 percent of GDP this year and 2.6 percent in 2014 from 13.6 percent in 2009.
The government is struggling to meet some of its targets. Net ordinary budget revenue rose 3.4 percent this year through August, compared with the targeted annual increase of 13.7 percent, the Finance Ministry said on Sept. 20.
Prime Minister George Papandreou said Sept. 21 that Greece would like to pay less than the 5 percent that the IMF-EU loans cost. The country sold six-month Treasury bills in September to yield 4.82 percent, more than 10 times what Germany pays for similar securities. The country hasn’t sold 12-month bills since April, when the yield was then 4.85 percent.
“There’s no need to do a longer period when you’re not happy with the interest rates available,” Papaconstantinou said on Sept. 8.
Greece has to meet quarterly targets to receive loan installments. Short-dated bonds have rallied since mid-August after the EU and IMF said in the first review that Greece had made a strong start in the deficit-cutting program, allowing the release of a second installment of aid. Two-year yields declined to 8.7 percent from 11.6 percent in the past month.
“Assuming Greece is on track and preparing to return to primary markets, there will be a critical point at the end of 2011 where Greece could ask for an extension of the repayment schedule of the EU/IMF loans,” BNP Paribas’s Sokos said. “That would make it easier for investors to feel confident about Greece and start purchasing bonds again.”
The EU-IMF agreement obliges Papaconstantinou to produce 6.6 billion euros of extra revenue and spending cuts of 2.6 billion euros next year to reduce the deficit. This year, he pledged 4.6 billion euros of cuts, while revenue measures added 1.3 billion euros.
“The focus on 2011 will be to deliver on the revenue side, which for any country is difficult, much less Greece,” said Anke Richter, a strategist at Conduit Capital Markets in London. “Without any progress there, it’s hard to imagine investors will have the confidence to give Greece money.”
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