Bond investors seek safety before Greek vote

Failure by the two main Greek parties to secure a comfortable majority in Sunday’s elections could put pressure on wider euro zone peripheral debt markets by casting doubt over popular tolerance of further reform.

Without implementing the austerity prescribed by its international lenders, Greece would cease to receive bailout funds, paving the way for a second debt restructuring and, some analysts say, threatening its membership of the euro.

Others say that undertaking the reforms could lead Greece to the same fate by choking the recession-ravaged economy.

Greece completed the biggest sovereign debt restructuring in history in March, imposing massive losses on private creditors and swapping old bonds for new ones with a lower interest rate.

The last polls published before an April 20 cutoff showed S ocialist PASOK and conservative New Democracy, w hich are part of technocrat Lucas Papademos’s government, should between them eke out a wafer-thin majority in the 300-seat parliament.

Unable to gauge last-minute sentiment, investors are going into the vote on Sunday – the day the French choose their president in a second-round runoff – on the defensive, favouring safe triple-A rated bonds. «If Greeces coalition doesn’t get enough members of parliament then definitely there will be underperformance by the periphery,» Lloyds Bank strategist Achilleas Georgolopoulos said. «The market reaction will be more evident on the periphery, with Spain and Italy hit the hardest.”

Greek bonds should also come under pressure but analysts said they might not be the best gauge because they are illiquid and prices are at rock bottom.

But Spain would be more vulnerable. Its high public deficit and banks burdened with bad property loans have put it at the epicentre of the euro zone crisis, making its bonds sensitive to any change in sentiment towards riskier debt.

Lloyds recommended buying top-rated 10-year Austrian and Finnish bonds versus Spain before the election – betting on a relative rise in Austrian and Finnish debt prices – given German bonds, the euro zone benchmark, were already expensive.

Failure by the Greek pro-bailout parties to win a sufficient majority or agree on a coalition could see the premium investors require to hold 10-year Spanish bonds over Finnish and Austrian paper hit euro-era highs, Georgolopoulos added.

The Spanish/Finnish 10-year yield spread last stood at 384 basis points, compared to a high of 398 bps touched in November. The Austrian equivalent was at 319 bps versus a 328 bps high hit in August.

“The market or the hedge funds have positioned themselves that both France and Greece will have governments that are not that friendly towards the troika (European Commission, ECB, IMF). That only spells higher volatility,» said Athanasios Ladopoulos, founding partner of Swiss Investment Managers.

Investors might want to buy core markets and sell the peripherals to hedge against that, he said.

“If something goes wrong in Greece that might have a domino effect on Spain and down the road on Italy, so peripheral countries might come under further pressure, especially if it is a more leftist coalition coming into the Greek government.”

Greek 10-year bonds trade at about 24 cents in the euro and yield about 20 percent, reflecting expectations G r eece will be unable to avoid a further debt restructuring.

Whoever wins on Sunday must agree additional spending cuts of 5.5 percent of economic output, worth about 11 billion euros for 2013-2014, and find about 3 billion more from better tax collection to keep the aid flowing, the IMF has said.

That will be tough for Greece in its fifth year of recession and with an unemployment rate of nearly 22 percent in January.

“If you look at the price of the new Greek bond … it’s already priced in another restructuring, another big haircut,» Alessandro Giansanti, rate strategist at ING said.

“When you see very depressed prices, it reflects not only the possibility of a second default but a real possibility that this bond will be redenominated in a different currency.”

The Greek and French votes take place against the backdrop of a debate about whether austerity is the best remedy for the euro zone’s ills or whether pro-growth policies should be given greater prominence.

Markets have hitherto worried that a rise in the power of parties less keen on austerity may derail the region’s drive for fiscal discipline. This h e lped push the 10-year French/German bond yield spread wider in recent months as Socialist Francois Hollande emerged as favourite to replace Nicolas Sarkozy as president.

“The good news for Greece could be that if Hollande does win in France it may well change the emphasis in terms of the policy prescription that is coming out of Europe towards more growth-oriented policies, which could be a silver lining for not only Greece, but for many peripheral countries,» said Sanjay Joshi, head of fixed income at London and Capital, a $3.5 billion fund that got rid of its Greek debt two years ago.