Greek worries cast shadow on eurozone bonds

Worries about Greece have cast a shadow over eurozone bond markets, pushing up longer term government borrowing costs for countries such as Spain and Italy despite the launch of quantitative easing by the European Central Bank.

Yields on Italian, Spanish and Portuguese 10-year government bonds, which move inversely with prices, dipped on Monday on a modest easing in tensions - but remained significantly higher than before the ECB started its large-scale asset purchases on March 9.

The wider "spreads" - or difference - between the yields on bonds of countries on the eurozone "periphery" and "core" countries such as Germany suggest the impact of QE has been constrained by renewed worries over the stability of Europe's monetary union.

"There is a correlation between periphery 'spreads' and the wider tone in credit markets, of which the mood over Greece is part," said Peter Goves, fixed-income strategist at Citigroup. "Until we see headline Greek risks subside, we expect a softer tone to persist in the periphery."

Other factors have almost certainly also pushed "periphery" yields higher - including increased issuance of longer term debt by southern European governments, especially compared with shortages of German Bunds. But the protracted stand-off between Athens and its creditors has also weighed on sentiment.

JPMorgan Asset Management on Monday saw a 50 per cent chance of "some form" of Greek sovereign default. Stephanie Flanders, chief market strategist for Europe, argued a partial default might not cause lasting damage to European markets if handled carefully. "But at a minimum, investors should be prepared for a messy few months for Greek financial markets - and some potential volatility in other European markets as well."

Analysts warned Greek "event risk" would remain high in the weeks ahead as eurozone leaders put pressure on Athens to agree reforms and the Greek government faces a series of deadlines for payments on loans from the International Monetary Fund and on bonds owned by the ECB.

Despite their recent volatility, however, the increases in Spanish, Italian and Portuguese yields have been far less dramatic than at the height of the eurozone debt crisis in 2012 - which has encouraged investor hopes that the fallout from a possible Greek default or even exit from the eurozone might be relatively modest.

Luca Cazzulani, deputy head of fixed income strategy at UniCredit, said: "Greece of course matters in the sense that it affects the general market mood but it doesn't dominate. You get 50 basis point daily swings in Greek yields - but maybe only two or three basis points in Italian and Spanish yields."

Worries about Greece may also have had an impact on German government bonds - increasing their appeal as a haven. While Greek yields have soared, German 10-year yields fell to a low of less than 0.08 per cent early last week - down from almost 0.4 per cent before QE was launched. The drop was largely the result of the ECB's large-scale purchases but a sudden jump in German 10-year yields back to 0.16 per cent two days later may have been at least partly the result of an easing of worries over Greece.

Mr Cazzulani said: "QE has been more effective in insulating the periphery than in insulating German Bunds - at least if you look at statistical correlations."

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