The supremacy of Greek bonds over their Italian counterparts may not be new, as that was also the case last year, but this time analysts estimate it will last longer because Greece’s weapons won’t be easily matched by its eurozone peer.
Greece has stood out in the bond market during the first half of the year as it is the country to have benefited the most from the European Central Bank’s extraordinary bond-buying program: From 4 percentage points in March, the yield of the Greek 10-year bond has tumbled to just 1.25 percentage points, meaning Greece’s cost of borrowing has shrunk 69%. At the same time, the Italian bond yield has dropped about 30% to 1.35 percentage points.
“While both countries face challenges, their growth prospects and their respective fiscal trajectories are dramatically different. This divergence between their fundamental outlooks supports the long-term trend of Greek bonds outperforming Italy’s,” argues Robert Tipp, chief investment strategist and head of global bonds for PGIM Fixed Income.
“Having said that, Italian bonds are still poised to outperform bunds based on their higher yields and ECB support despite their current path of credit deterioration. Over time, however, Italian bonds are likely to encounter more turbulence as a result of political instability, weak economic results, and difficulty in controlling their debt burden. Greece, on the other hand, stands to recover more rapidly from the Covid-19 crisis, and return to its track of fundamental improvement, and eventually ratings upgrades,” says Tipp.
“Market sentiment toward Greece has improved since the coronavirus-induced jump in Greek government bond yields early in March. The major catalysts for the drop in Greek borrowing costs are the ECB’s inclusion of sub-investment grade Greek government bonds under the new and recently extended Pandemic Emergency Purchase Program, the probable benefits from the European Commission’s Recovery Fund, the government’s sizable cash reserves, and the lure of extra yield on offer. These factors will keep yields suppressed, alleviating some of Greece’s funding concerns in the short term.” notes Luka Raznatovic, eurozone economist at Oxford Economics.
“Greek bond yields are now roughly the same as Italy’s. While it may seem hard to fathom, we believe the comparable rates aren’t unreasonable at the moment despite the difference in credit ratings. In contrast to Italy's debt structure, the vast majority of Greek debt is still owed to the official sector, reducing the risk of default on its small slice of privately held debt. Yet it’s important to note that, as the government issues more bonds over time, the composition of Greece’s public debt will shift back to being privately held, meaning credit risk can re-emerge,“ Raznatovic adds.
He goes on to point out that “The sustainability of Italian debt will be a recurring theme over the coming years, with the public debt forecast to rise to around 160% of GDP this year. Similar to Greece, the shield put in place by the ECB should be sufficient to cap Italian government bond yields. But questions will remain once the ECB’s PEPP ends. Given the sheer magnitude of Italy’s public debt, it’s almost impossible to see Italy being bailed out.“
Nick Wall, co-manager of the Merian Strategic Absolute Return Bond Fund, Merian Global Investors, notes his company “own Greek and Italian debt. We are positive on both due to the ECB’s commitment to lowering aggregate real yields in the eurozone, and the easiest way to do this is via tighter spreads. Whilst PEPP is the most well-known program, there is a plethora of other policy actions that support Italian and Greek government bonds such as lowering collateral requirements, more generous regulatory treatment of sovereign debt on bank balance sheets and a credible backstop via the ESM’s pandemic credit line. We are also encouraged by the progress of the recovery fund which would plug a big gap in the eurozone’s institutional architecture.”
“Greece’s performance has been exceptional, however, and in our view, is down to a couple of key factors. First, the government’s handling of the crisis has been very strong – not only has this allowed the Greek economy to open up quickly and accept tourists from countries with a similarly low number of cases, but it has also increased investor confidence in the region. Second, GGBs relatively illiquidity has been a double-edged sword – when the whole world demanded cash in March, the lack of market depth in Greek debt meant that GGBs were marked a lot wider. As liquidity returned, however, helped by Greece’s inclusion in PEPP, Greek debt has rallied hard,” according to Wall.
“Given that much of Greece’s debt is in the form of long-dated official loans, its gross financing needs are low compared to Italy – as sentiment turned and as the ECB started looking for bonds, Greek bonds became harder to source and perhaps there is even some scarcity value attached to them now with no issuance expected over the summer,” he comments.
For Antoine Bouvet, senior rates strategist at ING, “Greece is trading through Italy” because “the ‘free float’ of Greek sovereign debt (the private debt investors can buy and sell) is relatively small, unlike Italy’s. This means the ECB doesn’t have to buy much to have a strong market impact.”
“Secondly the terms on the rest of the debt held by public institutions such as the EFSF are very advantageous: long maturity and low interest rates. This means Greece does not have a very high refinancing risk, the amount of debt they need to sell every year, contrary to Italy. This is all the more true that Greece went into this crisis with elevated cash buffers which also reduce the need to ramp up debt sales as quickly as Italy had to,” argues the ING strategist.
“The combination of higher demand (ECB) and lower supply comparatively explain that Greece trades through Italy. I do expect this to continue until we see a stabilization of deficits and of debt sales which might take until next year,” Bouvet says.
As for the possible threats to the Greek bonds’ course, they mainly concern a delay to the disbursement of EU support. Jens Peter Sørensen, Chief Analyst, Danske Markets says “the risk factor is mainly if the recovery fund is not passed through or we see a second wave of the coronavirus, and DZ Bank comments that “should the start of the EU recovery fund be delayed, investors are likely to focus their attention primarily on the liquidity situation in the EMU countries. At present, the government in Athens still has sufficient financial reserves. However, Greece is likely to consider further bond issues in order to prevent liquidity from falling to the crisis levels of 2012 and 2015.”