Italian Bonds Reveal Speculation on Greek Deal Creditors Doubt

Updated on

Take a look at government bonds and you’d be hard pressed to detect the pessimism Europe’s leaders are expressing about the chances of a deal that can save Greece’s place in the euro zone.

Investors are cutting the yield premium they demand to hold the bonds of Europe’s more-indebted nations instead of benchmark German securities amid speculation a deal can be reached. Greece must deliver a detailed economic package to creditors on Thursday to win a new funding deal. Chancellor Angela Merkel is willing to let Greece go if Germany doesn’t consider its plans credible, said two officials familiar with her strategy.

“Markets appear more optimistic than most of the Greek creditors themselves,” Benjamin Schroeder, a Frankfurt-based interest-rate strategist at Commerzbank AG, wrote in a note to clients.

The yield spread between 10-year Italian and German bonds tightened 11 basis points, or 0.11 percentage point, to 144 basis points as of 4:32 p.m. London time. The difference widened to as much as 199 basis points on June 29, the first trading day after Greece called a referendum on austerity. In 2011, the spread reached 575 basis points.

The spread between Spanish 10-year debt and German bunds narrowed 12 basis points to 143 basis points on Thursday.

Pacific Investment Management Co. Chief Executive Officer Douglas Hodge said he was hopeful of an agreement can be reached. The reaction in markets to the Greece’s funding woes has been “relatively small” even as time runs out, he said.

Draghi Comments

European Central Bank President Mario Draghi suggested that Greece’s debt troubles are getting increasingly difficult to fix. He made the comments to Italian journalists late on Wednesday, hours before deciding to not increase the amount of Emergency Liquidity Assistance Greek lenders receive from the central bank.

On Thursday, Italy’s 10-year yields dropped to as low as 2.14 percent, with the bonds erasing all their losses since the referendum was announced.

“There is a ray of hope that a deal can still be struck,” said Orlando Green, a fixed-income strategist at Credit Agricole SA’s corporate and investment-banking unit in London. “We’re still very much on the knife edge of what could transpire. The Grexit risk is still sizable.” In bonds, “it’s a general risk-appetite move, albeit a moderate one, reflecting that the market still sees the chance of a deal,” he said.

China Rebound

German bunds fell with Treasuries as demand for haven assets waned after a rebound in Chinese stocks and oil prices. Germany’s 10-year yield rose six basis points to 0.73 percent.

“While the outlook for spreads appears digitally dependent on the outcome for Greece, core valuations also have an eye on the developments in Chinese equities and the commodities markets,” Commerzbank’s Schroeder said.

Backstopping the bonds of peripheral nations is speculation that the European Central Bank will boost monetary stimulus if spreads widen. And next week, investors will also get back 16 billion euros from redemptions in Italian bonds. That’s another prop for the nation’s bonds, Commerzbank’s Schroeder said.

“We are slightly surprised by the poor performance from the German curve,” Peter Chatwell, a fixed-income strategist at Mizuho International Plc, wrote in a note to clients. “This could be a result of the market’s gloom leading it to factor in more PSPP,” he said referring to the ECB’s bond-buying program. It “will flatten the German curve at the long end while tightening sovereign spreads.”