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Yield-hungry investors eye the European landscape

Mounting fears over Greece's debt crisis have created some eye-popping yields among Greek and other European government bonds - but anyone developing an appetite for them will need a cast-iron stomach, market watchers say.

As Greece's turbulent parliament prepares for a critical vote this week on a major austerity program, Greek government bond prices are plumbing new depths, driving yields through the stratosphere.

The payout on Greek two-year paper is bumping up against 30 per cent, double where it was three months ago, while 10-year bonds are yielding nearly 16 per cent. (By comparison, Canada's two-year bonds yield 1.4 per cent and its 10-year bonds are just under 3 per cent.)

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Government bond prices have fallen throughout much of Europe amid fears that a default by Greece would have a domino effect on other heavily indebted countries, as well as the banking systems of healthier European economies. Ireland's and Portugal's 10-year bond yields have surged to more than 11 per cent, while Spain's 10-year debt is yielding 5.6 per cent and Italy's is at 5 per cent.

For yield-hungry investors, those surging payouts may be tempting - especially with some strategists now saying government bond prices aren't likely to get much lower, even for some of Greece's most debt-ridden European neighbours.

"We remain of the view that the larger 'non-core' markets (Italy, Spain, Belgium) offer a more than adequate risk premium," wrote Francesco Garzarelli, chief interest rate strategist at Goldman Sachs. "Intra-EMU [bond]spreads discount a lot of uncertainty already."

However, investors may find that more volatility and even higher yields may still lie ahead as the Greek drama plays out over the coming weeks.

"We continue to think that the markets are complacent about the potential implications of the crisis in Greece. … There is still considerable uncertainty about the ripple effects throughout the global financial system," said Julian Jessop, chief international economist at Capital Economics in London. "Overall, we don't accept the argument that Greece is too small to matter, and that a default is somehow 'fully priced in.' "

It Ain't Over Till...

Pierre Lapointe, global macro strategist at Brockhouse Cooper in Montreal, said that based on the outcomes of similar sovereign-debt crisis in other countries, Greek bonds may still be a bit above their eventual bottom. Greece's 10-year bond is trading at about 55 per cent of its par value; Mr. Lapointe said something between 30 and 40 per cent would be more typical as the bonds enter default or major restructuring.

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"There's still one last leg in the European debt saga," he said.

The most likely solution to the crisis appears to be a so-called "orderly default" - a voluntary restructuring of Greece's debt in the next year or two to reduce the payout obligations to bondholders. But even then "there's going to be a ripple effect" in other euro zone countries, Mr. Lapointe said.

"This will bring volatility to European [bond]markets in general."

Mr. Jessop argued that an orderly restructuring could actually increase the risk for investors in some of Europe's other lower-quality government bond issues.

"If Greece somehow gets away with restructuring its debts fairly painlessly, other countries may well be more tempted to follow," he said in an e-mail interview.

Safe Haven: Germany

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The uncertainty has caused European bond investors to increasingly turn to Germany as the rest of the European bond market has struggled. The 10-year German yield has retreated from 3.5 per cent in mid-April to less than 2.85 per cent last week, while the cost of credit default swaps (CDS) on its debt has fallen in recent weeks, in contrast to the trend in most of the rest of Europe. A CDS is a form of insurance that protects a lender in case of a default.

However, German yields and CDS prices both rose to begin this week with the crucial Greek vote looming - perhaps evidence that as the Greek drama unfolds, the heightened risk surrounding Europe could again create some buying opportunities in the region's more stable bond markets.

Mr. Lapointe says investors might want to wait for some of the uncertainties surrounding Greece to clear up - or for bond prices to get even cheaper - before venturing back into the volatile market for European government debt.

"We still think it's a bit too early to jump back in," he said. "There might be a better entry point down the road than right now."



Yield %

Basis point change vs. year ago

France 10-yr.



Germany 10-yr.



Italy 10-yr.



Spain 10-yr.



Sweden 10-yr.



Swiss 10-yr.



Greece 10-yr.



Portugal 10-yr.



Belgium 10-yr.



Ireland 10-yr.



Source: Bloomberg

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About the Author
Economics Reporter

David Parkinson has been covering business and financial markets since 1990, and has been with The Globe and Mail since 2000. A Calgary native, he received a Southam Fellowship from the University of Toronto in 1999-2000, studying international political economics. More

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