The euro and eurozone peripheral bond markets rallied on Monday in response to moves by European policymakers to tackle the region’s 18-month debt crisis.
The Brussels’ agreement to increase the size and scope of the eurozone’s rescue fund and the reduction of interest rates for Greek bail-out loans were singled out by investors and strategists as the main positives for the eurozone.
The euro jumped against most currencies, rising 0.7 per cent to $1.40 against the dollar, while European bank stocks were up amid hopes that the Brussels deal would help steady the currency club’s beleaguered financial sector.
Greece was the biggest beneficiary among the peripheral economies as its stock market rose 5.15 per cent – the largest rise since May 10 last year, the day the international community announced the €750bn “shock and awe” rescue package.
The Greek bond market saw its biggest leap in two months. Greek 10-year benchmark yields, which have an inverse relationship with prices, fell half a percentage point to 12.43 per cent.
The leap in Greek bonds was even greater in shorter-dated maturities as these had sold off more sharply last week because of rising worries that Athens would default. This followed the multi-notch downgrade of the country’s debt by Moody’s, the rating agency. Greek three-year yields fell 64 basis points to 17.58 per cent.
Rallies in the other peripheral bond markets on Monday were more limited, while their stock markets finished the day mixed, as many investors warned the boost to sentiment could prove short-lived.
Irish 10-year benchmark yields fell 15 basis points to 9.49 per cent and Portuguese 10-year yields dropped 16 basis points to 7.44 per cent.
The rally was also not strong enough to alter market expectations that Portugal will have to seek bail-out loans, or change views that Greece would end up defaulting on its government bonds.
For example, the fall in Portuguese two-year bond yields to 6.32 per cent, a 30 basis point drop on the day, still leaves the country’s short-term cost of borrowing far too high to be sustained without external help, say strategists.
The chance of a Greek default over the next five years also remains above 50 per cent as measured by credit default swaps. The consensus market view is that Athens will not be able to grow strongly enough to reduce its record high public debt.
It is also significant that bond yields peak at three years in the Greek debt market. This is because investors and strategists fear the risk of default is greatest beyond the summer of 2013 when the permanent crisis mechanism, the European stability mechanism, takes over from the temporary rescue fund, the European financial stability facility.
It is at this point that investors will be expected to share some of the burden of potential sovereign defaults.
Elsewhere, the International Swaps and Derivatives Association is looking at whether credit default swaps for Ireland should be paid out following the country’s bail-out.