EURO GOVT-Periphery rallies on signs of new rescue fund powers
Thu Jul 21, 2011 12:35pm EDT
* Greek short-end leads broad peripheral debt rally
* Investors welcome new, expanded role for EFSF rescue fund
* Long term risks remain, but rally to continue in near term
By
William James
LONDON, July 21 (Reuters) - Peripheral debt rallied strongly on Thursday as investors welcomed draft documents suggesting that European leaders would agree to expand the role of the region's bailout fund as part of a deal to rescue
Greece.
Yields tumbled on short-dated Greek debt, down more than 4.5 percent in the two-year segment, while the more liquid Italian and Spanish debt
markets also showed substantial relief. The region's triple-A benchmark German debt sold off sharply.
Draft conclusions of the highly-anticipated summit showed a the European Financial Stability Facility could gain sweeping new powers aimed at rescuing debt-laden Greece and stemming the spread of the region's debt crisis.
"The rumours around these draft conclusions have already got the market moving positively, and I think think that has further to go," said Niels From, chief analyst at Nordea.
"It really shows, in the 11th hour, leadership from the
euro zone leaders."
Analysts focused on the EFSF element of the wider plan as the most likely to bring relief because it could potentially address the systemic threat seen in the last two weeks as
Italy and Spain have been dragged into the debt crisis.
"The size of the EFSF, currently 440 billion (euros), is still on the low side to keep it credible in the future. Therefore if they would increase the volume of the EFSF ... then it would be extremely helpful," From said.
The European Central Bank signalled, in a policy reversal, that it is now willing to let Greece default temporarily under the crisis response that would also involve a bond buyback and a debt swap, but no new tax on banks.
Dealers marked prices on peripheral debt higher, pushing yields on 10-year Greek debt 76 bps lower on the day to 16.7 percent. Yields were down across the region's lower-rated states, but traders said the degree of buying behind the moves had so far been limited.
"A lot of real money accounts have been sitting on their hands and saying they weren't prepared to jump till they saw this finalised," a trader said.
"A lot of them are very underweight peripheral markets and overweight Bunds so I would assume these guys are going to start giving up those positions, which could exacerbate the moves we've seen today."
Bund
futures FGBLc1 fell by more than a full point, settling 113 ticks lower at 127.01. Italian and Spanish bond yields edged further away from the 6 percent level seen as the threshold of debt sustainability, falling to 5.368 percent and 5.76 percent respectively.
RISKS REMAIN
Much of the short-term relief seen in bond markets was the result of investors who had been pessimistic that policymakers would be able to reconcile their opposing positions buying back debt to square up short positions, market participants said.
This highlighted that while the proposed solution was being broadly welcomed, risks to the longer-term picture remained and could add a note of caution to investors' sentiment.
"This all seems to tick most of the boxes but there's still huge execution risk ... even if it does answer all the market's questions, it's still a very long process," said Charles Diebel, head of market strategy at Lloyds Bank.
"Should you get too carried away at this point in time? No. But has a degree of systemic risk been lowered? Yes."
The yield on 10-year German government bonds rose by 11.5 bps to 2.88 percent, and traders were targeting a return to 3 percent if conclusions to the summit were broadly in line with expectations.
