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.