My big fat sell-off

A successful bond issue provides only temporary respite Jan 28th 2010 From The Economist print edition THE Greek finance minister, George Papaconstantinou, must feel like a man who finds a one-euro coin on the pavement only to discover he had earlier dropped a five-euro note. Worries about Greece’s public finances seemed to recede on January 25th when it raised €8 billion ($11 billion) in an issue of five-year bonds. That appeared to kill the idea that Greece may not be able to tap bond markets for much-needed cash. Yet two days later the yields on Greek government bonds jumped to their highest since 1999. The sell-off renewed fears that markets may lose faith in Greece altogether. Talk of a bail-out by its euro-zone partners is growing. The country’s initial fundraising success came at a hefty price. The new five-year bonds will pay a coupon of 6.2%, a 3.5 percentage-point spread over the “mid-swaps” rate, a yardstick for creditworthy borrowers of euros. Yet the deal suggested there is appetite for risky sovereign bonds at the right price. The bank syndicate placing the bonds was able to drum up €25 billion-worth of orders in a few hours. If the Greek government had decided to meet all that demand, it would now be halfway to meeting its gross borrowing requirement for this year. According to Fitch, a credit-rating agency, Greece needs to raise €51 billion this year to cover its budget deficit, to roll over its short-term borrowings and to redeem its maturing longer-term debt, much of which comes due in April and May. The reasons for leaving money on the table seemed sound at the time. Issuers typically like to have oversubscribed offerings: it makes it more likely that bonds will rally once the deal closes. Greece may have hoped that by showing markets that it could raise cash so readily, it would be rewarded with lower borrowing costs for future issues. A grab for money might also have been taken as a sign of weak commitment to budgetary discipline. Any reward for restraint did not last long. On January 27th the bond markets smacked Greece down again. The interest-rate spread on its five-year government bonds widened to a record 4.1 percentage points over German bunds. That change was mirrored in higher prices for credit-default swaps, a form of insurance against default (see chart). There seemed to be no single proximate cause of the sell-off in Greek bonds. Financial markets were in a general funk, caused in part by America’s bank-reform plans and in part by worries about policy-tightening in China. Investors fleeing from risk drove the dollar up and pushed the yield on one-month Treasury bills into negative territory for the first time in ten months. Closer to home, Portugal’s government announced that its budget deficit was 9.3% of GDP in 2009, higher than previous forecasts. It also said that the deficit would narrow only slightly to 8.3% of GDP this year, adding to the sense that troubled euro-area countries are not doing enough to right their rickety public finances. Perhaps most unnerving of all were reports, later denied by Greece, that it had tried and failed to place bonds worth €25 billion with China. The rumour struck at the notion, cherished by some holders of Greek bonds, that there is untapped demand in Asia for the riskier sorts of euro paper. For less sanguine investors, the idea of going cap in hand to China smacked of desperation. Some may have recalled the trek that Bear Stearns made to China in the months before the bank imploded. The bond market’s skittishness puts more pressure on the Greek government to come up with a credible plan for fiscal retrenchment. A pledge to follow Ireland’s example in making substantial cuts to public-sector wages may now be necessary to ensure Greece can fund itself at reasonable cost. Having raised €8 billion this week the Greeks probably have enough money to see them through until May, when a chunk of their long-term borrowing falls due. The danger now is that market sentiment spirals out of control. If that happens, only the most radical measures, or a euro-zone bail-out, will turn things around