There’s a 30 percent chance Greece ends up dropping out of the euro area by accident and if it does then that might make Italian and Spanish debt a good buy, according to the manager of the world’s biggest bond fund.
Pacific Investment Management Co.’s central scenario is that Greece will muddle through and keep using Europe’s common currency. There’s a possibility of a debt payment being missed unintentionally and that would cause a blowout in bond spreads for the region’s other highly indebted nations, Mihir Worah told reporters in Sydney on Thursday. Pimco has reduced its bets on Italy and Spain to guard against that risk.
“We want to reduce our risk and have some dry powder to buy assets in Europe because we think a Greece exit will be volatile,” said Worah, Pimco’s chief investment officer for asset allocation and real return. “But at the end of the day it’s not going to impact the global economy, it could be a buying opportunity if you’ve got the wherewithal and you’re not in pain yourself.”
Euro-area finance ministers will meet in Riga, Latvia, on Friday in their latest attempt to persuade Greece to commit to economic reforms so that aid payments can be released before the country runs out of money. The Greek government led by Alexis Tsipras has been tussling with its creditors since it was elected in January and a deepening of the crisis could also help drive up borrowing costs for the region’s riskier debtors such as Portugal, Spain and Italy.
Italy’s 10-year bonds yielded 1.40 percent as of 9 a.m. on Thursday in London, 125 basis points more than similar tenor German debt. Equivalent Spanish bonds were at 1.37 percent.
Worah, who helps oversee Pimco’s $117.4 billion Total Return Fund, said the premiums offered by Italian and Spanish debt are likely to narrow from current levels because of the European Central Bank’s bond-buying program. The yield premium over 10-year bunds may tighten to about 60 or 70 basis points, he predicts.
“We’ve taken some chips off,” Worah said in reference to Italian and Spanish bonds. “We still fundamentally think on a probability-weighted basis this position makes money.”
Pimco sees the euro dropping to parity with the U.S. dollar within a year as the Federal Reserve starts lifting its key interest rate from September. The common currency was at $1.0673 on Thursday in London.
Worah said he’s not differentiating much between Spanish and Italian debt and that a bet on those notes is more likely to make money than lose money, even with a 30 percent chance of a Greek accident.
“Our base case is that Greece stays in the euro zone, but it’s going to be messy,” he said. “There’s a fat tail being priced by the markets, there’s about a 30 percent chance that there’s an accident and something bad happens and Greece leaves Europe.”