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Thursday, April 10, 2014

Greece exits the wilderness and returns to the markets

It has been labelled by some as the “amazing comeback”. Greece has this morning sold €3 billion of five-year bonds at an interest rate of 4.95% - and the demand exceeded €20 billion.

To be fair, the turnaround in investor sentiment with regards to Greek debt is pretty astonishing and the demand for the first Greek bond issue has outstripped even the most optimistic forecasts. As the newswires pointed out this morning, it increased quite significantly overnight:

But this outcome has left a few people scratching their heads and wondering what this means for Greece and the eurozone – both of which continue to struggle when judged on a broader set of data indicators. Below, we try to address some of these questions in a reader-friendly Q&A.

Why has demand been so strong?

There are a couple of reasons for this, and they have little to do with Greece.
  • The bond auction remains small, and the yield fairly decent relative to other peripheral economies and 'junk' or high yield bonds of similar length. And there will always be investors looking for a better return. After all, even in the immediate aftermath of the Greek debt restructuring there were plenty of investors willing to take a punt on the newly formed bonds in the secondary market – and many of them ended up with good returns.
  • This links to a broader problem in Europe, and even in developed economies – the shortage of safe assets and the lack of yield. Given the rock-bottom interest rates and dwindling inflation, the level of return available on many financial instruments is not what it used to be, and investors are keen to find new avenues to boost their gains.
But isn’t there a huge amount of risk involved?

Actually, given the structure of the deal and the environment involved, maybe not as much as one would expect (click on the graph to enlarge).

  • Firstly, the bonds will be issued under English law. This will stop them being restructured in a similar fashion to the previous Greek bonds, meaning that the investors have significantly stronger legal protection.
  • Secondly, the maturity of the debt is quite short, especially relative to the very long term (20+ years) maturity on the loans from the eurozone. This ensures that payment of these bonds falls well before Greece needs to start paying off its official loans – as the graph above highlights.
  • Thirdly, the ECB’s promise to purchase government bonds if the crisis escalates again still stands. Furthermore, this has been combined with greater support from the eurozone for Greece and a new aversion to write downs of sovereign debt. 
  • All of this means the likelihood of losses on Greek private sector debt has been significantly reduced. It has not been eliminated, but if any write-down were to be forthcoming it would most likely be losses on official sector loans, not least because they now make up 66% of Greek debt.
This has almost come out of nowhere in the past week or two: why such a rush?
  • The first, obvious reason is Greece’s need for further funding. The issue of a funding gap this year and over the coming years (estimated to be around €20bn up to 2016) has been well covered. This bond issue, combined with some new fiscal measures and probably the leftover capital in the Greek bank bailout fund, will help fill most of that fiscal gap over the next couple of years. It also potentially paves the way for further debt issues.
  • However, there are deeper political reasons. As shown by yesterday’s anti-austerity strikes, this morning's bombing outside the Bank of Greece and the dwindling majority of the government in parliament (which now stands at only two seats), there still is a significant amount of political uncertainty around. The government seems to harbour hopes that this return to the markets will galvanise its support, and act as a symbol of the turnaround it has helped to create.
  • Furthermore, with the European elections around the corner and the opposition SYRIZA party looking set to do well, the government seems to believe that this issue could somewhat also boost their support at the polls.
But how much of a turnaround does this really signify for Greece?

While it’s certainly a positive, the macro level data for Greece remains worrying. As the charts below show (courtesy of Natixis), unemployment remains very high. In particular, youth and long-term unemployment are both stubbornly high, and threaten to become a drag on the economy in the longer term. While business activity has stopped its decline, the hope of a swift recovery is yet to be based on clear evidence. There is a long way to go in the structural reform programme, as highlighted by the 329 reforms recommended by the OECD.

More broadly, Greece’s long term strategy for competing and growing in the eurozone remains unclear, and it has zero room to absorb further economic shocks. Citi - forever bearish on Greece - took it upon themselves to be the buzzkill amongst all this optimisim with the chart below (via FT Alphaville). Ultimately, it remains a small symbolic step, especially given the size of the bond issue.

 Will Greece get to spend this money as it wishes?

That seems hopeful at best. While Greece may have a little more flexibility compared to when the funding comes from official loans, of which almost every penny is clearly assigned, there will be little wiggle room. As even those countries outside bailout programmes have found, the oversight at the eurozone level is now quite significant. Greece’s budget still has to be agreed in tandem with the EU/IMF/ECB Troika, and little flexibility is likely to be allowed, especially since there is already an outstanding funding gap which needs to be filled.


Jesper said...

In this case the buyers might hope to see signs of a default before the rest of the market and hope they can trade out of the position.

Maybe there'll be no default before maturity, maybe there'll be some interest payments made and a trade out of the position can be made with a profit.
The bet is made with someone else's money anyway so the finance professional will make the bet. "Heads I win, tails you lose."

Rik said...

At the end of the day Greece was and still is a mismanaged and financially totally overstretched country.
Nobody in his right mind should lend against 5%. A riskpremium considerably below equity.

However all assets look overpriced so bonds, relatively short ones, look not too bad. As long there is no real inflationrisk (like now with the Euro). As long as the ECB/EZ sort of guarantees at least it looks like you get nominal back, which is uncertain for nearly all other assets.

Longer term somebody will however end up with all this crap. Basically one of the reasons people buy is the fact they assume that the stuff is liquid. Largely when the excrements hit the rotating airreplacer hoping for the greater fool.

The Euro crisis is a combination of fiancial, economic and political issues which are interconnected on top of that. Imho what markets largely miss is that political risk is very likely to play out over a very long period. Basically it can be summarised as a relevant country either getting austerity fatigue or bail out fatigue in a way that it severely influences national policy making. Read a president LePen, a PM Wilders, a Bunga 3.0 or a Greek ultra-whatever direction.
Politics doesnot work according to the economic lines, when it looks to work as markets seem to buy it it is likely to continue working.

Greece has de facto both austerity fatigue risk as well as bail out risk. Austerity fatigue usually hits in after approx 2 years (probably somewhat later in Europe because of the welfarestates). Bail out hard to tell, but having bought the Ukraine lately will definitely not be very helpful.

Another point. Basically all friendly rates for the PIIGS are on the back of Germany and Co. Without Germany the ECB is only a printeing machine. Seen how much de facto is guaranteed by the North EZ it starts to look that they will get overstretched themselves. Especially when real growth seems non existent.

Anonymous said...

This is madness. It is obvious that certain finance "professionals" have learnt nothing since the Credit Crisis and MananaZone melt-down of 2008 and onwards.

With more EU-driven austerity on the cards this is casino 'investing' at best. At worst this is wanton recklessness with investor cash.

Ongoing QE by the US is distorting asset prices to the point whereby it is impossible to earn a decent return - unless you take a massive amount of risk and invest in Greek sovereign bonds, for example.


Rollo said...

Not madness, but simply a bet that the EU will continue to be forced to support Greece and other southern economies, for fear that the dream of the United States of Europe will crumble. It will take a few years before they wake up, and the dream vanishes.

Anonymous said...

What would you choose?

1. Lending to Greece at 5% : Poor repayment history/have defaulted. No willingness to pay or collect taxes. Euro straight-jacket prevents devaluation and competitiveness. Dire debt situation and high chance of further bailouts wit the rich continuing to leave the country...

2. UK-based Social lending platforms @ 5% to 5.8% : Low chance of default, capital and interest protection mechanism in place, little or no political risk etc

Someone please explain to me how lending to Greece at 5% p.a. makes any sense?!!

It is madness.


Denis Cooper said...

Rollo has it right in that investors think these Greek bonds are fully guaranteed by the rest of the EU, by the ECB and by the other governments of the other eurozone countries through the ESM, and especially of course by the government and taxpayers of Germany. They came to assume that was the case before with the bonds issued by the Greek government, even when the EU treaties said otherwise, however I think that any doubt about that has been removed.

Rik said...

That plus the fact that there is simply too much money around in markets.

-All look overpriced.
-No real alternatives available. All degree of bad.
-Lots and lots of excess liquidity.
-Financial investors accepting ridiculously low risk premia.
-All counting on the liquidity of markets to be able to exit.
-Markets going up much faster than realistic extrapolate trends and a likely duration of the crisis and it becomes totally unrealistic.

At some point (may be even now) risk will get too big and people will go for cash (or similar like risk free bonds). Lots of sellers and few buyers, some will get badly burnt.

Problem is pricing in. All the rubbish that people see or better start to see while be priced in in a few days.
As nearly everybody see it as overpriced and are counting on liquidity likely big

Markets are imho getting the risk completely wrong anyway on EZ bonds. They have been focussing on relatively short term political risk (the one determined by politicians) and financial risk.
And assume the ECB is similar to the FED.

The main danger is imho longer term political risk (the one mainly determined by the electorate).
Most likely scenario. North gets fed up. Start to vote massively for populists. Put main stream parties under pressure. On a European level austerity will be dumped upon the PIIGS. Where mismanagement and hidden rubbish will cause uproar. Something Southish leaves (everything better than the Euro). From there the whole thing falls into pieces and eg Greek bonds become totally worthless again. Priced in over a very short period and like before some people will really suffer.
The issue is imho social tension in countries. That becomes national political pressure that becomes EU political pressure.
As long the South doesnot reallu reform the problems will come back. The issue is they are not competitive. More the fact that they now have ended up in the most overcrowded group (EMs and the whole of Eastern Europe) than cost per item produced. The real world looks at the first thing when to invest, EU politicians at the second (make your bets).

ECB is nothing without Germany and Co. And unlike the US Germany can leave or refuse to cooperate. If so the ECB is as good as a guarantor as my goldfish.