The bond market is finished? You can only lose money in it from now on? That was very much the consensus in the market at the end of last year. But no one told investors in Europe. The one roaring trade for the start of 2014 has been euro-zone peripheral debt, with yields tumbling in the crisis-hit, debt-loaded nations within the euro.
The trouble is, it is going end in catastrophe.
Right now, the PIGS — Portugal, Ireland, Greece and Spain — are flying. But that can’t last.
Investors are taking a big bet that the euro-zone crisis is gradually being fixed, that yields will start to converge again across Europe, and the banking system will stabilize. They are wrong on each count. In reality, the fault lines in the system are growing worse, it is just that right now they are under the surface. When the crisis flares up again, as it inevitably will, there will be huge losses on those bonds. And the banks will be in a deep crisis again.
For the last six months euro-zone peripheral debt has been the asset to own – and it has kicked off the New Year with an even stronger performance. The yield on Greek 10-year bonds is now just 7.7%. Back in the summer it was above 11%, and at the peak of the crisis when many people thought it was about to get kicked out of the single currency, yields topped 30%.
There are plenty of signs the market has turned. The Irish government has returned to the debt market and found plenty of demand. So have the Portuguese. Italy auctioned bonds on Monday at the lowest yield since 2011. The Greeks even said last week they were contemplating resuming private bond sales again this year. The PIGS really are flying.
If the definition of a bubble is a market that has become completely divorced from reality, and only wants to hear good news, then this is the biggest bubble we have witnessed for some time.
True, Ireland is genuinely in better shape than it was. But Ireland was always the exception. It was already a wealthy, competitive economy (one of the five richest in the world, remember) before the crisis began. And it exports mainly to the U.K. and the U.S., both of which have been growing this year — 18% of Irish exports go to America, and 17% to Britain. When your main customers are doing well, it is not that hard for an economy to recover.