With the outcome of the weekend referendum known and markets grappling with the result and possible implication in the short-to-medium term, Greece’s government scrambles for a fresh wave of negotiations with its creditors, with a new finance minister this time at the helm of the lobbying team.
There is too much at stake for all parties involved and one would shudder to think what would happen if Greece were to ultimately leave the single-currency region, not only for the Greeks themselves but also to the EU and the impact and lack of confidence it could translate to with international investors on the stability of the euro.
Inevitably, peripheral spreads remain vulnerable to Greek event risk over the near-term. Following the large volatility witnessed in recent trading sessions, and looking beyond the second quarter, we would expect a "relief rally" for credit to prevail in the scenario that further clarity on the Greek scenario is sought. Furthermore, we view the cash flow dynamics for credit over the summer months to be supportive, whilst medium-term funding concerns are likely to remain.
Specifically, sovereign credit risk has pretty much moved out of the limelight and market risk is the order of the day, dictating sovereign yield direction. The Greece factor and elections in certain countries in Europe, however, remain threatening. And this only means that spread direction will not only be driven by the large volatility witnessed in the Bund but also by major peripheral macro or credit news.
The sharp rises in the 30y Bund and BTP yields witnessed over the past couple of months are clearly one of the fastest moves on record, with this period offering little economic and financial news, whilst the spread between the two assets remained stable.
The large moves merely created a sense of extreme uneasiness among investors, making them shy away of the asset class, rather than adding additional exposure to bonds, despite remaining bullish overall on the direction of rates and credit. This essentially led to investors blaming “liquidity” conditions for the uncertainty of bond markets.
On the buy side, the ECB is currently enjoying favourable liquidity conditions. In addition, euro area sovereign bond markets continue to expand as the positive net issuance has increased the amount of bonds in circulation, and this has also brought with it an increase in volumes and bond and futures trading.
However, on the other side of the trade, it seems to have become increasingly difficult to carry out large transactions without impacting prices, and this further exacerbates the liquidity conditions of credit markets. And this primarily boils down to two key factors of equal importance.
Firstly, risk premiums are rising from historical lows and secondly, market makers have their hands tied on how much risk they can take on their books, which has encouraged the investor herding behaviour.
The stand-off between the creditors on one end (IMF, ECB and the EC) and the Greek government on the other is still alive and kicking, and at this stage it is pretty much a case of who is going to give in first, and this could also come at the expense of a further deterioration in the Greek economy.
Disclaimer:
This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.