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Greece Falters And Bonds Rally

Greece is a small country that makes up only tiny proportion of the European Union economy but the prospect of it defaulting on its debts last week saw its 10 year bond yields move dramatically higher.

As the edge of the cliff — being failure to repay its loan from the International Monetary Fund — came closer without resolution, the yields rose.

On 1 July 2015 the Greek 10 year government bond yield was 14.98 per cent but had risen to 19.23 per cent just a week later on 8 July. It would have been a brave investor that bought at that point! Once the new deal was signed, the yields moved lower and as of Wednesday night were 12.06 per cent.

Significant uncertainty causes nervous investors to sell higher risk investments and seek safe havens in the lowest risk investments. Thus, investors sold off Greek bonds and the yields rose. There was a corresponding flight to quality with increased demand for US and German government bonds pushing yields on those bonds lower.

A week before the crisis, US 10 year government bonds were trading at a yield of 2.42 per cent but closed at the height of negotiations at 2.19 per cent, a substantial move.

Australian dollar 10 year bonds followed a similar path trading at 3.01 per cent at the start of the month, then contracting to 2.74 per cent on 8 July, before closing at 2.97 per cent on Wednesday 15 July.

10yr government bonds various

The graph shows the volatility of a range of government bonds since 1 April 2015. A couple of other points are worth making:

  1. US 10 year government bond yields have been creeping higher as the world expects US interest rates to increase in the near term.
  2. When Greek bonds spiked, the US and Australian bonds reacted similarly, both are viewed as ‘safe haven’ although the US is considered the safer of the two.
  3. Look at the very close relationship between Italian and Spanish bonds, the differences are marginal, both having settled at around 2 per cent. Note, for the month of April, the 10 year rate was less than 1.5 per cent, so does not show on the graph.
  4. Greek bonds are now trading at just over 12 per cent. This is a very high yield in a low rate environment. Bond investors are not convinced the latest deal will rescue Greece and keep it within the EU.

For what it’s worth I think interest rates here and in the rest of the world will be much lower for much longer than anyone thinks. Seven years on from the GFC and inflation is still impossibly low. For the last five months, US inflation has been zero or slightly negative. In Australia, it remains well within the RBA target range, giving RBA board members no cause for concern.

While Governor of the US Federal Reserve Janet Yellen came out this week stating she still expects to lift rates this year, another blow up in China and Greece may give cause for a further pause.

At best, I expect Australian rates to be flat with the risk being to the downside, that is, for another 0.25 per cent rate cut or two.

Elizabeth Moran is a director of education and fixed income at Sydney-based bond broker, FIIG Securities.

She is a specialist on the bond market and regularly presents at conferences across Australia. Elizabeth is the editor of FIIG's weekly newsletter The Wire and is the is the author of "The Australian Guide to Fixed Income".



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