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It's either irrational exuberance that the worst is over for Greece and the other peripheral countries. or, more likely, a recognition by bond traders that the eurozone deflationary crisis is deepening and yields have further to plunge, supported by stepped-up ECB bond-buying to counter the deflationary threat) Fears grow over scale of eurozone bond rally By Ralph Atkins Financial Times April 10 2014 Greece used to be a byword for bond market trouble. But the country’s successful return on Thursday to global capital markets rode a rally that has sent eurozone government borrowing costs tumbling – in some cases to record lows. Athens’ success in shaking off, at least partly, its eurozone “bad boy” image highlights investors newfound confidence in crisis-hit countries on the region’s periphery. Orders for a €3bn issue of five-year bonds exceeded €20bn. But the forces driving down eurozone yields, which move inversely with prices, are much broader. As investors seek out better performing assets, the periphery has become a haven for investors fleeing troubled emerging markets – and expectations are growing that the European Central Bank will soon embark on “quantitative easing”, or large-scale asset purchases. The scale of the declines, however, is raising worries that the rally has gone too far. “It is becoming a funny world,” says Erik Nielsen, chief economist at UniCredit. “I fear the market may have got the ECB wrong.” With the effects spilling into corporate debt, worries about market frothiness have grown. Lowly-rated Greek banks can now issue bonds at interest rates paid a decade ago on 10-year UK and German government bonds, notes David Lloyd, senior portfolio manager at M & G Investments. “Even in a world of super low interest rates, that looks pretty far from being OK to us.” Investors have seen good reasons for cutting the yields they demand on eurozone government debt. At the height of the debt crisis, periphery bonds were treated as “credit markets”; as with “junk” corporate bonds, investors fretted about default risks. As the eurozone crisis eased, thanks to ECB pledges to preserve the eurozone’s integrity – and politicians’ progress in strengthening Europe’s monetary union – Italian and Spanish bonds traded like “rates markets”, moving more in line with US Treasuries or German Bunds, traditionally regarded as risk-free. Spanish and Italian five-year yields have now fallen below UK equivalents. Not only have default risks fallen for periphery countries, inflation is exceptionally low, which could justify even lower rates. While nominal bond yields have fallen sharply, real yields – taking account of inflation – are “still very high” and could fall further relative to German Bunds, argues Andrew Bosomworth, European portfolio manager at Pimco. Japan’s experience over the past two decades shows how government bond yields can defy expectations and edge ever lower, Mr Bosomworth adds. “Investors asked: how can they go lower? But they kept on going down because if you deducted inflation – which was nothing – they were still relatively high.” As worries about the eurozone falling into a damaging deflationary phase have grown, the ECB has readied itself to launch QE. Last week, Mario Draghi, president, said its governing council was “unanimous in its commitment” to using unconventional policies to head off any deflation risks. In the US, QE drove Treasury yields significantly lower – with much of the impact ahead of implementation. Something similar may be happening in the eurozone. “As you move from QE being an out-of-the-money option to a more likely option, you would expect [bond] prices to move – and that is what we’re seeing. But we’re still not where we would be if it were ‘at the money’,” says Laurence Mutkin, head of global rates strategy at BNP Paribas. He reckons the spread, or difference between Spanish or Italian ten year bond yields or German equivalents – currently about 160 basis points – could fall a further 70 points. One risk is that some investors take profits from the recent rally, sending yields higher again. Greek 10-year yields rose on Thursday, suggesting some were exiting after placing orders for its new five-year bonds. A bigger danger is that markets have miscalculated the ECB’s intentions. While the central bank has simulated the effect of a €1tn purchase programme, QE may be some way off – and may not take the form of US-style government bond buying. Mr Draghi has indicated it may prefer to boost credit flows in southern Europe by buying packages of bank loans to small- and medium-sized enterprises in the form of “asset backed securities”. The difficulty for the ECB, however, will be finding sufficient volumes of such assets to buy. “Only the government bond markets are deep enough for meaningful QE,” says Mr Mutkin at BNP Paribas. And yields might have further to fall whatever form ECB action takes. “Yes, the market feels a little over excited about QE, given what is feasible and, yes, some people are overemphasising outright government bond purchases,” says Matt King, head of credit strategy at Citigroup, “but speculation that the ECB will do something is supportive for all risk assets.” Additional reporting by Elaine Moore and Andrew Bolger ________________________________________________ Send list submissions to: Marxism@greenhouse.economics.utah.edu Set your options at: http://greenhouse.economics.utah.edu/mailman/options/marxism/archive%40mail-archive.com
