Bond Markets Hedging Risks Amidst Hopes for Greek Solution

Amidst higher hopes for the last-second Greek deal, the US Treasuries and Deutsche Bunds went down and up in value, respectively, though they are holding firm amidst the wild swings in the global markets, affecting riskier assets.

Kristian Rouz – Although the renewed Greek optimism pushed US equity markets up slightly, triggering a limited sell-off in safer assets, investors are still wary of the still possible negative developments in Europe, with Grexit imminently hitting the common currency along with the peripheral debt.

The US debt went down in price slightly, despite little US exposure to Greece, while the overseas debt markets have reacted overtly optimistically to the news from Greece, with Italy even selling some more bonds just after a two-day drop in debt value.

Benchmark 10-year US Treasury yields were up 2 basis points early on Tuesday to 2.3531%, with value down 6/32 as hopes for a Greek solution reversed investors’ rush for safety. The 30-year US debt paper retreated 11/32 in value with yield rising to 3.1162%.

Despite the sentiment over the Greek debt, the stalemate became calmer on Tuesday compared to the previous day amidst the advent of the more constructive proposals. There is still a lot of uncertainty that is likely to render global financial markets unstable and swinging between gains and losses this week. That said, the demand for safer fixed income, including Treasuries and Deutsche Bunds, remains stable.

In German debt, yield on the 10-year Bund were down by just 0.05%, to 0.744%, while the value was up insignificantly. The Greek bonds, meanwhile, have crashed after the S&P cut its rating on Greece to CCC-. Rest of Europe’s periphery fared better though, with bonds of Portugal and Spain edged up slightly on Tuesday, the former, however, saw an increase in 10-year yield by 0.025%, but that’s only a negligibly negative.

Italian bonds have halted their drop in valuation on Tuesday only to see the nation offering to the market another 6.8 euros worth of debt, indicating Rome is perceiving the Greek situation overtly positive as Italian bonds are not in prime demand given the odds of the current financial turmoil.

Italy is selling 2.9 bln euros worth of 10-year bonds and 1.5 bln euros worth of 5-year debt securities. Meanwhile, investors’ demand for both types of assets is at its lowest since December.

Rome must have a solid faith in the European Central Bank ultimately coming to Greece’s rescue, as there is no risk appetite in Europe at all, and buying into Italy’s debt is surely a risk. However, Italy’s bonds are still liquid assets, and the market situation is to change dramatically in a matter of hours.

Surprisingly, Italy’s 10-year debt yield fell 0.02% to 2.37%, while the price rose 0.19 or 1.90 euros per 1,000 face amount, to 92.475.

Meanwhile, the common currency was down 0.44% to $1.1185. The currency market’s biggest winner is the UK sterling thus far amidst the better outlook for the real economy’s expansion this year, and the euro’s weakness is now determined by the widespread sentiment that Greece would not pay its 1.6 bln euro tranche to the IMF, while still narrowly avoiding a default with the ECB help. Such a circumvention of the rules is certainly creating a market-unfriendly situation in currency trading.

The euro is poised to go down against the US dollar no matter the outcome of the Greek debt stalemate for two reasons. First, in the event of Grexit a huge wave of uncertainty will spook investors considering the common currency.

Second, if Greece stays in the Eurozone, the financial costs to support the sinking economy ruled by the leftie spendthrift government will create sizeable holes in the European financial sector.

For the US, though, Greece is still a factor as, amidst the optimistic macro data (with June consumer confidence jumping to 101.4 from 94.6 in May) the last-second Greek deal will mean a closer Fed move to raise base interest rates, a stronger dollar and slower growth.