Greek Fixed Income Monitor: Bond Swap: The End of an Era
2017 was undoubtedly the year of Greek bonds as it was marked by important events that strengthened the confidence of the markets and pushed government bond prices to historical highs. Following the successful completion of the second assessment of the Greek program as well as the expectations for improved liquidity conditions and macroeconomic outlook, the Greek Government Bond Index closed at 468.9 points at the end of December, up 10.2% on a monthly basis, after reaching a record high of 471 points on 18/12/2018 and recording significant gains over the last two months of 2017.
The index's upward trend was preceded by press reports about the exchange of PSI bonds since mid-September, which the markets immediately priced in, while the official PDMA announcement took place in mid-November. The market expectations for the bond swap led the index average yield to 5.05% at the end of November and to 3.99% in December, 337 basis points lower than at the end of the previous year. Indicatively, in the two-month period from November to December, 10-Year yield declined by 119 basis points. to 4.07% while the 2-Year bond recorded a drop of 129 bps reaching 1.54%.
Although the bond swap does not have a substantial effect on debt, it signals a change in the confidence level of markets in government issues. The expectations of a recovery in the Greek economy and the imminent completion of the 3rd review of the Greek programme also point to this direction. Specifically, since the beginning of the year, the Index has boosted by 35.13%, a rate well above the 6.9% of the Eurozone government bond index.
In line with the downward trend in government yields, the spread between Greek and German 10-year government bond yields has declined significantly since the beginning of the year by 321 basis points, reaching 508 bps at the end of November and 369 bps at the end of 2017. However, this improvement overestimates the fundamentals of the Greek economy. In particular, the valuation model, which focuses on the relative macroeconomic figures between Greece and Germany, shows that the fundamentals have not improved to an extent that could justify a spectacular improvement in spread, making it undervalued (more expensive) by 100 bps.
As bond spreads do not follow the fundamentals in the short term and given the improvement in market expectations, the high yields of the Greek 10-year bond continue to be more attractive compared to rest of the European region, thus we cannot dismiss the possibility that the 10-year spread may remain underestimated for longer. Therefore, with Greek government issuance attempting to exploit the positive climate and to bridge the gap between the issues of the European region (The 10-year spread of Portuguese bonds reached 152 bps in December) and since the medium-term measures for the debt may be discussed in 2018, major moves in the bond market are expected in 2018.
The Corporate Bond Index remained stable in December, up only marginally by just 0.35% on a monthly basis, reaching 134.9 points. On an annual basis, the index ended in 2017 with profits of 6.35%, i.e. very close to the levels of high-yield European bonds and significantly strengthened against the 3.73% increase last year.
Although the dynamics of the Index has weakened since mid-November, this move appears to stem mainly from increased demand for government bonds rather than a change in fundamentals. The subdued domestic banking financing of the non-financial business sector (remained flat in October) and historically high valuations in the high-yield international bond market make Greek corporate issues an alternative market offering higher returns than the norm.