Toing and froing of risk in Greek bailout

Ever since the election, markets have feared that Greece would reject its existing agreements with the European Central Bank (ECB) and the International Monetary Fund (IMF), causing a default that would force a ‘Grexit’.

The past six months have been like sitting through the longest Wimbledon tennis match combined with a Greek tragedy, as we watched an endless toing and froing of finger-pointing and claims of “unfairness” between the country and its creditors.

The market seemed to expect, or at least hoped, for a deal, only to see Greece react combatively. This caused tremendous uncertainty, of which bond markets had to defend against.

European government bond markets reacted swiftly to headline news throughout the crisis – bond markets generally have a knee-jerk reaction to uncertainty.

News that a deal would be more likely caused Greek government bonds (considered risky) to rally, which means their yields tightened or decreased while prices went up. On days when a deal seemed unlikely, Greek government bond markets sold off, pushing prices down and yields up – bond prices have an inverse relationship with yield.

News that Greece was likely to comply with the ECB’s demands caused European bond markets to take the ‘risk-on’ stance, selling the safety of German bonds and buying the bonds of countries that are associated with more risk, such as Spain, Italy and Portugal. When Greece seemed defiant against the ECB’s plans, the ‘risk-off’ trade was on, causing Germany and France to rally while the Spanish, Italian and Portuguese bond markets sold off.

The tennis match has come to a conclusion, with the European Union ultimately getting its way. Greece acquiesced to the ECB’s demands and voted in favour of the new bailout bill, which includes a $96bn (£61.4bn) three-year package.

In spite of all the toing and froing, the final passing of the deal set a crucial precedent: other eurozone countries with rising anti-austerity parties, such as Podemos in Spain, should not be encouraged to mimic Greece’s behaviour if they were to come to power.

Dysfunction and finger-pointing in Europe has spread outside of Greece and its creditors, and now exists between the two monetary authorities – the ECB and the IMF.

The IMF says the ECB’s latest package is not sustainable, the new reforms are not enough and that debt relief for Greece is required. This sheds doubt as to whether the ECB and the eurozone went about this in an effective way.

But the ECB is not alone in receiving blame, as some have criticised the IMF’s role in Greece’s inclusion in the eurozone in the first place. It’s only a matter of time before we can decide who was right.

Heather McArdle is director of fixed income indices at S&P Dow Jones Indices

Timeline of risk-on/risk-off drivers in 2015

February 9 2015 – Risk off

Following the election of prime minister Alexis Tsipras, the S&P Greece Sovereign Bond index yield hikes to 11.62 per cent (from around the 8 per cent area in autumn 2014), while the S&P Spain Sovereign Bond index widens by 8 basis points (bps) to 1.08 per cent (prices fell), and the S&P Italy Sovereign Bond index widens by 7 bps to 1.25 per cent from the previous day’s close.

April 27 2015 – Risk on

Greece announces it will replace finance minister Yanis Varoufakis to negotiate with its European creditors. This is seen as a positive step for negotiations. From a week earlier, the S&P Greece Sovereign Bond index tightens by 145 bps, the S&P Spain Sovereign Bond index tightens by 13 bps, while the S&P Germany and France Sovereign Bond indices yields widen.

May 26 2015 – Risk off

Lack of developments in Greece, and concerns over a rising anti-austerity party in Spain, cause the S&P Greece Sovereign Bond index to widen by 60 bps, the S&P Spain Sovereign Bond index to widen by 6 bps and the S&P Germany Sovereign Bond index to tighten by 4 bps from the previous day’s close.

June 29 2015 – Risk off

Greece indicates it will not be making the €1.7bn (£1.2bn) payment to the IMF. Standard & Poor’s Ratings Services downgrades the country to CCC- with negative outlook. Greek banks shut and strict capital controls are set. The S&P Greece Sovereign Bond index widens by 472 bps. The S&P Spain, Italy and Portugal Sovereign Bond indices widen by 20-23 bps, while the S&P Germany Sovereign Bond index tightens 8 bps.

July 6 2015 – Risk off

Greece votes ‘no’ to a referendum on further austerity measures proposed by the ECB. The S&P Greece Sovereign Bond index widens by 453 bps, the S&P Spain, Italy and Portugal Sovereign Bond indices widen by 8-10 bps, while the S&P Germany Sovereign Bond index tightens by 2 bps from the previous day’s close.