Eurozone government debt is turning investors away from the highly publicised Piigs nations and onto countries with different budgetary issues
In 2010, the tale of sovereign debt in the eurozone region can be separated into Portugal, Italy, Ireland, Greece and Spain (the Piigs) vs the other countries (the non-Piigs). Investors have been rotating away from highly publicised Piigs in favour of debt from countries that are not experiencing the same financial and fiscal budgetary issues.
From the perspective of the entire region, eurozone government debt has provided positive returns for investors in 2010. The S&P Eurozone Government Bond Index, capturing all eurozone sovereign debt with a maturity greater than one year, has returned 1.33% to 27 April. During the first three months of 2010, yields moved consistently lower across the curve and investors in Eurozone debt were rewarded with handsome returns. An overriding theme emerged in April with short-term rates moving considerably higher as investors rotated into longer-dated debt in the search for higher yields.
With yields in shorter maturity debt falling to near 1.25% in March and yields at the other end of the curve holding north of 4%, investors have been rotating to longer-dated debt capturing higher yields. This rotation has been significant in April with a 48bps flattening of the yield curve occurring (yield curve measured as difference in YTW for 10+ year index over the one- to three-year index). Yields at the short end have moved considerably higher, 59bps in April, resulting in a nearly 1% loss for the S&P Eurozone Government Bond one- to three-year index over the month. The April loss has essentially wiped out the year-to-date gain for this maturity segment. Although yields at the long end of the curve have moved marginally higher in April, they have dropped 11bps since the end of 2009. With yields dropping and higher coupon accruals to bond holders, the S&P Eurozone Government Bond 10+ year index has recorded a 3.68% year-to-date return.
A second theme has appeared in the eurozone region over the past six months: the risk in sovereign credits needs careful analysis.
Credit default swaps have been criticised for the effect they have had in the region, but one might argue the derivative instruments simply represent a more efficient view of the risks currently perceived by the marketplace than the prices of the corresponding bonds. As can be seen in the graph below, CDS spreads for Portugal, Italy, Ireland, Greece and Spain have been extremely volatile with the cost of buying default protection well above the spreads for protection on France and Germany debt. On 28 April, Greek CDS was quoted north of 900bps according to CMA DataVision. This level is the highest for any sovereign tracked by CMA.
Not surprisingly, the debt of Greece and Portugal has dramatically declined in terms of returns and has greatly underperformed the debt of the other eurozone nations. Greek debt is down 18% in the month of April and nearly 20% year to date. The debt of Portugal has seen a large decline as well, falling almost 9% in April. There has been less of an effect on the remaining Piigs, with the debt of Ireland, Spain and Italy down approximately 4%, 2% and 1% respectively.
With investors selling bonds of Portugal and Greece, the prices of other eurozone debt, particularly that of Germany and France, have been the primary beneficiary. Debt of both countries have seen modest increases in April, approximately 0.75% and are the best performing countries in the eurozone region.
Perhaps the biggest benefactor from the financial problems Greece is dealing with has been investors in US Treasuries. Often viewed by global investors as the ultimate safe haven, US Treasury bonds, especially longer dated, have seen a huge run up in April. The S&P/BGCantor US Treasury Bond Index is up nearly 1% month to date to 27 April outperforming every nation in the Eurozone region. The 20+ year sub index is up 3.46% in the same period generally outperforming most other asset classes.
With a confluence of news and actions being taken, including Standard and Poor’s Ratings Services its rating on Greek debt to speculative and lowering its ratings on Portugal and Spain, the debt of the entire region experienced large declines in returns in the second half of April. Across the maturity segments, all sub indices of the S&P Eurozone Government Bond Index family, with the exception of the 10+ year sub index, saw declines of 1% or greater. The long end of the curve has held up exceptionally well as investors looked to the higher-yielding bonds.
When investigating the composition of the various maturity sector sub indices, one can easily see the bonds of Greece and Portugal have been the primary driver of returns. The worst performing maturity sector, the seven- to ten-year bucket has the highest concentration of Greek and Portuguese debt at 8.28. The 10+ year bucket has a 6.48% Greece/Portugal concentration, considerably lower than the main index and the other maturity segments.
This underweight of these sovereign names in the longest-dated maturity segment may highlight that investors have been less willing to provide unsecured financing for extended periods to countries with substantial budget deficits that are well above EU guidelines. Although Greece has successfully brought some debt to market, it has been very short term in nature.
Market reactions to news and events impacting Greece, Portugal and Spain have been reflected in the yields demanded by lenders. The indices designed to measure the Eurozone Government debt markets give us insight into how the market place is reacting during this volatile period of time.
Mike Kondas, associate director, fixed income at S&P Indices
