The Mystery of the Risk-Free Greek Bond

Bond markets don’t think Greece is less risky than the U.S. It is the difference between European and U.S. bonds that should be drawing investor attention.

By Richard Barley


CROSSOVER
Government bond yields




If you thought markets were insane when the yield on European junk bonds fell below that of the 10-year Treasury last year, look away now: the two-year Greek yield has recently fallen below the two-year U.S. yield.

Once again, the comparison is flawed. U.S. and Greek bonds are denominated in different currencies with very different monetary-policy settings. The U.S. two-year Treasury yield, now 1.96%, has been steadily rising as the Federal Reserve has been raising rates and signaling more to come. The European Central Bank is still printing money, albeit at a slower pace, and its key deposit rate is negative.

Markets don’t think Greece is less risky than the U.S. The relevant risk-free comparison for Greece’s two-year yield of 1.68% is Germany, where it is minus 0.61%. The Greek two-year yield (in reality a 16-month yield since the bond matures in April 2019) is in fact still above Germany’s 30-year yield of 1.25%. Greek yields are only just getting back in touch with their eurozone peers.


FURTHER APART
Two year government yields

 
There are still interesting conclusions to draw, however. The hunt for yield is clearly still going on, and in the eurozone, Greece is the final frontier. The enormous drop in Greek bond yields might be reason to be cautious; the move might be too much, too soon. But rather than exiting the euro, Greece may finally exit its bailout program in 2018. A convergence between Greek and eurozone yields is a necessary part of that process.

The bigger consideration is the extraordinary monetary-policy gap that has opened up between the U.S. and the eurozone. Although the debate around the ECB is about how and when it removes stimulus, it is still far from raising rates, and will be years behind the Fed when it starts doing so. That German two-year yields are negative and more than 2.5 percentage points below U.S. yields is the real oddity for markets.

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