By: Dr. Mike Campbell
Governments use bonds as a mechanism of securing financing from the markets. Traditionally, government bonds have been regarded as a low risk investment vehicle since the prospect of default is remote. However, in the aftermath of the global financial crisis, national debt and the cost associated with it has come under scrutiny.
The first Eurozone sovereign debt crisis was triggered by the fact that the outgoing Greek government had fudged the figures when it joined the Euro and that the economic position and debt problems were much more dire than they had let on.
Market faith in Greece was badly shaken and Eurozone partners were furious about the misrepresentation of the Greek position. The new government vowed to get the country’s debt problem under control and brought in unpopular, but necessary austerity measures which provoked a degree of civil unrest.
The markets began to think the unthinkable; that a modern, European sovereign nation might default on its debts. This forced the yield up on Greek bonds to a point, ultimately, when an EU/IMF rescue package was needed to ensure that Greece could honour her obligations. The market was not wholly reassured by the bailout package or the safety net that the EU hurriedly put in place and attention shifted to other highly indebted nations; notably Ireland, Portugal, Spain and Italy.
After Ireland accepted a bailout to help ensure the future of its banking sector which had become hopelessly over-exposed when the Irish property bubble burst, all eyes turned o Portugal and Spain. Higher bond yields had led to speculation that Portugal would be next in line and the Euro slipped on the fears. However, a bond auction on Wednesday sold nearly €2.5 billion of 4 and ten year bonds at 5.4 and 6.7% respectively. The yields were lower than predicted and the auction went well.
In Spain yesterday, a similar auction raised €3 billion on 5 year bonds with a yield of 4.5%. The Euro has risen strongly on the news of these latest developments, making gains of more than 3 cents against the Dollar.