Europe Debt Crisis Abates as Traders See Yield Spreads Narrow
Four months after a European Union- led bailout, Germany’s biggest bond dealers say the worst is over for the region’s most-indebted nations.
Yields on government bonds of Greece, Spain, Ireland and Portugal will fall to within 2.2 percentage points of benchmark German bunds on average in the next two years from 4.61 percentage points last week, according to a Bloomberg News survey of 15 banks that trade directly with Germany’s debt agency. HSBC Holdings Plc, Europe’s largest bank by market value, Goldman Sachs Group Inc. and Societe Generale SA advise buying securities sold by Greece.
Bond dealers are confident that austerity measures will be enough to damp speculation the 16-nation currency union is in jeopardy of falling apart. Gross domestic product in the region will likely increase 1.7 percent this year instead of the 0.9 percent projected at the depth of the crisis in May, the European Commission said Sept. 13. Banks were given more time to raise capital levels to meet new regulations, reducing the likelihood they will need additional government aid.
“All the policy backstops have put a floor under the downside risks for peripheral euro-region bonds,” said Michael Vaknin, a senior fixed-income strategist in London at Goldman Sachs, which didn’t participate in the survey. “Spreads are near their records, but the EU and International Monetary Fund have pledged their support and opportunities are starting to emerge.”
HSBC and Goldman Sachs recommend Greek 30-year bonds as the price languishes at about 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 Spanish, Portuguese and Greek securities.
Pictet Asset Management ended bets that Irish bonds will underperform after yield spreads widened to a record.
“At the very end of August we closed our short position in Ireland,” said Mickael Benhaim, who helps oversee $60 billion of fixed-income investments at Pictet in Geneva.
Europe’s sovereign debt crisis took hold at the end of 2009 after Greece’s newly-elected Pasok government said the budget deficit was twice as big as the previous administration disclosed. In April, Greece asked to tap an EU-IMF 110 billion- euro ($144 billion) loan facility after being shut out of debt markets.
A month later, former Federal Reserve Chairman Paul Volcker said he was concerned the euro may face “disintegration” after the rescue package initially failed to stem a decline in the euro. It’s up 4.1 percent since then as nations began implementing austerity measures, after the currency fell 7.2 percent in the first four months of the year. The euro was little changed at $1.3044 as of 2:29 p.m. in London.
Equities also advanced as peripheral nations took steps to reduce their deficits. The Stoxx Europe 600 Index climbed 5.1 percent this month.
“Peripheral countries are meeting their stability targets,” said Christoph Rieger, the head of fixed-income strategy at Commerzbank AG in Frankfurt. “By the end of the year the picture will look quite encouraging on that count.”
Greek Prime Minister George Papandreou said on Sept. 12 that, while his country avoided “almost certain default,” it is necessary to stick to its commitments.
“Either we change Greece or we condemn it,” he said.
Bloomberg News asked the 32 banks that act as so-called primary dealers at German government bond auctions for their predictions for yield spreads between the 10-year securities of Greece, Portugal, Ireland and Spain versus benchmark bunds. Responses came from 15 of the banks under condition they only be used in aggregate because the forecasts haven’t been published.
The banks that provided responses were Banco Santander SA, Bankhaus Lampe KG, Barclays Plc, Deutsche Bank AG, UBS AG, UniCredit SpA, Commerzbank AG, Landesbank Baden-Wuerttemberg, Credit Agricole Corporate & Investment Bank, ING Groep NV, WestLB AG, Royal Bank of Scotland Group Plc, Bank of America Corp., Bayerische Landesbank and HSBC.
Greek 10-year bonds will yield 638 basis points more than bunds at the end of next year, from 913 on Sept. 17, according to the survey. The spread will likely shrink to 477 basis points, or 4.77 percentage points, in late 2012.
For Ireland, the spread will dwindle to 222 basis points by year-end 2011, and 155 in 2012, from 387. In Portugal, where the gap finished at 366 basis points last week, investors will likely accept a premium of 227 in 2011 and 157 a year later.
The Spanish spread will shrink to 126 basis points in 2011 and 91 in 2012, from 177 last week.
Spread narrowing will be modest this year with Greece at 809 basis points, Ireland at 299 basis points, Portugal at 293 points and Spain at 157, the survey showed.
Irish 10-year bonds fell today, sending the yield 17 basis points higher to 6.59 percent. The Portuguese yield rose 32 basis points to 6.48 percent and the Spanish yield increased 4 basis points to 4.25 percent. The Greek 10-year yield was little changed at 11.61 percent.
“There are definitely” some “opportunities in these countries for investors with a long-term approach,” Pictet’s Benhaim said. If you are an investor that has to mark-to-market positions “and you have to bear the volatility then it’s a bit trickier. Our time horizon is between three months and 12 months,” he said.
Credit Default Swaps
European bonds fell last week on renewed concern some nations may require further government aid.
An index of Greek, Portuguese, Spanish and Irish credit- default swaps, which insure against default, reached the highest level since June last week. Yields on Irish 10-year debt rose to the highest relative to bunds since at least 1991. The Portuguese-German spread approached the most on record. Trading in Greek bonds fell to 819 million euros in August from 30.8 billion euros a year earlier, the Bank of Greece said Sept. 14.
Irish bonds were the world’s worst-performing government securities so far this quarter, losing 3.2 percent, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Portuguese bonds were the second- worst and Greek debt the fourth, the indexes show.
“We don’t believe we are out of the woods in terms of sovereign-debt concerns,” said Robert Edwin Talbut, chief investment officer at Royal London Asset Management in London. “This is likely to remain a recurring issue for financial markets for years to come.”
Greece still faces a “substantial” default risk as insolvency prevents the nation from repaying its debt when its bailout program expires in three years, Andrew Bosomworth, a Munich-based fund manager at Pacific Investment Management Co., which runs the world’s biggest bond fund, said Sept. 6. Greece may need to extend its EU-IMF lifeline by another three to six years to avoid a default, JPMorgan Chase & Co. said Sept. 9.
“The failure to reduce risk spreads means that the public sector bailout is not working,” according to Mohamed A. El- Erian, chief executive officer at Pimco.
“It raises the risk of renewed contagion,” El-Erian, who is based in Newport Beach, California, wrote in an opinion piece on the company’s website.
While the derivatives market is pricing in a greater chance of default for Greece, Ireland, Spain and Portugal, the nations are still able to sell debt.
Yields fell at an auction of 4 billion euros of Spanish 10- and 30-year debt last week, as demand for the bonds due in 2020 was 2.32 times the amount sold and the bid-to-cover ratio for the securities maturing in 2041 was 2.1. Portugal sold bonds this month and Greece and Ireland auctioned bills. Spanish banks cut their reliance on ECB borrowing in August by 16 percent to an average 109.8 billion euros per day, Bank of Spain data show.
Irish Prime Minister Brian Cowen said on Sept. 16 his government is “very anxious to ensure we have a sustainable position going forward” and there is “no complacency” in achieving it.
Greece’s 30-year bonds “fully factor in the cost of a restructuring,” said Steven Major, London-based global head of fixed-income research at HSBC. “The market knows that there’s still a long way to go, but so far Greece has cut spending by more than they planned. That’s good news.”
Greece has made a “strong start” in implementing economic policies attached to its IMF loan, a staff report said Sept. 14. Spain’s central government budget deficit narrowed to 2.4 percent of GDP in the first seven months, from 4.7 percent a year earlier, the Finance Ministry said on Aug. 31.
Deficit reduction may be aided by a strengthening global economy. The German economy, Europe’s biggest, will expand 3.4 percent in 2010 and 2.2 percent next year, the Essen-based RWI economic institute said Sept. 15, citing an “unexpectedly strong” second quarter.
“We’re expecting growth to come through and stay reasonably solid so toward the end of next year they will be moving toward more sustainable levels of funding,” said Huw Worthington, a fixed-income strategist at Barclays in London, referring to borrowing costs in the peripheral nations.
2010 2011 2012 Greece High 1000 900 700 Low 650 450 120 Average 809 638 477 Ireland High 400 300 225 Low 190 150 50 Average 299 222 155 Portugal High 370 375 250 Low 170 140 80 Average 293 227 157 Spain High 210 250 150 Low 120 85 47 Average 157 126 91
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