* Greek bonds may struggle to rally further
* "Grexit" risks seen low but could resurface at any time
* Thinning volumes viewed as sign of vulnerability
By Marius Zaharia
LONDON, Jan 29 A powerful rally in Greek
government bonds, which has seen prices surge four-fold since
June, is running out of steam with investors still nervous the
bailed-out country could be at risk of leaving the euro zone.
Expectations - confirmed last week - that Greece would
secure further bailout funds and bets further losses will not be
imposed on private Greek bond holders have cut the return
investors demand to hold 10-year Greek bonds by two thirds from
record levels of 30 percent before elections last June.
Fears Greece could leave the euro peaked before the election
when, with voters enraged at mainstream parties that had imposed
harsh spending cuts, investors thought anti-bailout politicians
might come to power.
Those worries have since eased but, for the rally to go much
further, investors would effectively be pricing out any exit
risk, analysts said. This is seen as premature.
Economists and Greek debt holders say austerity measures
imposed by the conservative-led government could lead to further
social unrest and destabilise the coalition, whose narrow
parliamentary majority has already been cut by defections.
That could open the door to radical leftists, raising the
risk of a so-called "Grexit". The implications could be felt
beyond Greece, complicating efforts by Italy and Spain, whose
bonds are also rallying, to emerge from their own debt problems.
"There is still residual political risk around the coalition
amid the further cuts in spending that will be implemented this
year and if there was any political turmoil then talk of Grexit
would resurface," said Julian Adams, CEO at Adelante Asset
Management, who said he made close to 100 percent profit from
his position in Greek bonds last year.
Distressed debt brokerage Exotix has designed a pricing
model based on three equally-weighted scenarios: euro exit,
"staggering along" and economic recovery. That puts what they
call the "fair" average price on all Greek bonds at about 40
cents in the euro, versus 46 currently, implying an average
yield of about 11 percent versus 9.8 percent.
Current prices reflect an exit probability of 25 percent
based on that model and the firm's economist Gabriel Sterne, who
recommended investors buy Greek bonds for most of last year,
said this was too low and that it was time to sell.
"My view is based primarily on political and social risks.
You talk to anyone in Greece and they tell you they feel like
living a social experiment," Sterne said, adding risks were
skewed towards an even greater increase in the exit probability
than the current assumption of his pricing model.
If Greece were to leave the euro, average yields should rise
to 24 percent, whereas if Greece were to consolidate its euro
zone membership by returning to growth, yields should fall
towards 6.8 percent, Sterne said.
The yield on the Greek February 2023 bond was
last around 10.5 percent, about half what it was when the bond
was launched as part of a restructuring, under which the
government swapped old bonds for lower-priced new debt, in March
In Italy, whose debt, at about 1.3 times the size of the
economy is comparable with Greece's 1.5 times but which is not
seen at risk of euro exit, equivalent yields are
about 4 percent.
An indication that the rally could stall, or even sharply
reverse, is that traded volumes are thinning out, analysts say.
Trading peaked just before Greece, in a second attempt to
reduce overall debt, bought back some of its bonds at a discount
in early December, due to bets the remaining bonds, which
account for only a tenth of Greece's 300 billion euro debt pile,
will be repaid in full at maturity.
In September, October and November volumes were around 100
million euros per month, according to data from HDAT, the
trading platform operated by the Bank of Greece.
But that fell to 40 million euros in December. In January,
data for all but the last five sessions showed volumes of 56
billion. Six of the January sessions saw no trades.
Sohail Malik, lead portfolio manager for the ECM Special
Situations hedge fund, said he sees about three dealers a day
placing bids or offers in the market, down from as many as six
before the buyback. Offer sizes have fallen to 10 million euros
versus 50 million previously, he said.
"If there is a big holder that had to sell for some reason -
a hedge fund that has to meet some redemptions, or other issues
- this is a vulnerable market," Malik said. He expects yields to
stabilise near-term, saying investors need more information
before adding to or unwinding their positions.
If Greece made progress in implementing reforms prescribed
in its bailout programme and broader euro zone sentiment stayed
positive, yields could fall into single digits, he said.
This is in line with the view of Morgan Stanley, which said
in a note average yields on Greek bonds could fall to about 9
percent in the medium-term, assuming progress on the economy and
continued support from its lenders.
Malik says that if the governing coalition came under
pressure, 10-year yields could rise to as much as 15 percent.
Renewed exit worries would affect other euro zone members.
"If the ring is broken there are very negative market
effects for the whole euro zone," Malik said.