Greece’s payment obligations during June look intractable, and the challenging position facing the government was encapsulated when it used cash held with the International Monetary Fund to meet its May payments to the same organisation.
This predicament may force an 11th-hour deal for Greece and its creditors, resulting in Greece remaining a member of the eurozone. However, the negotiations remind us of Europe’s crisis management strategies over recent years, with compromise agreements appearing late in the day but often lacking sufficient completeness to make them anything more than short-term solutions.
The efforts by Mario Draghi, president of the European Central Bank (ECB), may be the exceptions to this rule, but he is only one of the interested parties in these discussions.
Until a permanent solution is found, Greece’s negotiations have the potential to add volatility to equity, bond and currency markets, which may be exacerbated by the seasonally lower market liquidity over the summer.
The Greek situation has overshadowed an improving macroeconomic environment in Europe over the past few months. This better economic news may have been part of the reason for the dramatic moves in bond yields seen during April and May.
The German ten-year bond yield bottomed at 0.05 per cent in late April, but in the next 14 trading days these ‘safe’ investments lost more than 6 per cent. These moves were probably also partially due to the over-exuberance of bond buyers believing that the ECB, through its quantitative easing programme, would buy their bonds at any price. The ECB may do so, but other market participants obviously decided to take short-term gains and run.
In fixed interest, we have taken a negative view on Western sovereign bonds for some time, as in our view the yields were unattractive and made the bonds riskier.
We believe the economic backdrop is improving so yields could rise, decreasing the value of these bonds. This was the correct stance to take in 2013, but not in 2014, as the yields on these bonds fell.
However, we have not changed our mind. If anything, our views have hardened, as these assets have ascended to prices where we consider only prolonged extremely low inflation or deflation would warrant a purchase.
We retain a preference for corporate bonds where higher yields have been on offer, and in the accommodating environment the world’s central banks are providing, we see little likelihood that default rates will escalate markedly when credit is freely available.
The fixed interest environment is made murkier when one looks into the future and thinks of the likely paths of interest rates and inflation.