GreeK Government Bonds Continue to Blowout

As concerns over Greece’s fiscal situation continue to mount, the country’s bond yields have blown out over the last few days. At nearly 9%, Greece’s 10 year government bonds yield 585bps points more than that of German sovereign debt (see charts below). Most perplexing about this continuing spread widening is that the EU and IMF have collectively pledged over €45 billion to help bail out the country. As such, I would attribute much of the rapid decline in Greek bond prices to technical factors relating to European banks dumping their holdings for fear of having to come clean to the investment community on their exposure. While Greece has continued to increase their estimate of their 2009 fiscal deficit (currently at 13.6% and climbing), I find it highly unlikely that this would be enough to deter the EU/IMF consortium from standing by its pledge to help. If they did, the contagion risks for other PIIGS nations would be felt immediately (particularly Portugal).

Many investors fear that bondholders will be forced to take a haircut, though Dubai’s recent bailout of Nakheel creditors (with funds that were previously received from its neighbor, Abu Dhabi) shows the pains that sovereign nations will go to in order to remain in good stead with external creditors. When fears over a Dubai World default gripped the investment community last fall, the holding company’s Nahkeel subsidiary bonds plunged to between 50 and 60 cents on the dollar. However, last month Dubai announced that maturing bonds would be paid in full, resulting in a huge gain for those hedge funds willing to bet that Dubai World wouldn’t let its troubled subsidiary go.

While Greece’s fiscal situation is untenable and requires severe austerity measures to bring under control, the recent plunge in its government bonds presents a good trading opportunity for those investors willing to bet that the EU and IMF will stand by their commitment. 

On a somewhat related point, I find it ironic how on one hand the German government is lambasting Goldman for selling it subprime bonds backed by troubled US homeowners and on the other hand they are about to write a huge check to bail out Greek pensioners. In a world marked by overlevered consumers and their equally irresponsible governments, there appears to be no easy choices for German savers.