One of Western Europe’s most dramatic bond-convergence trades this decade — Greece over Germany — looks like it will reward investors yet again in 2018.
London hedge fund Algebris Investments is among those betting economic momentum will take the country’s borrowing costs even closer to Germany’s after the Mediterranean country’s 10-year yield spread narrowed by about 44 basis points this month alone. Algebris says it may shrink by as much as 75 basis points.
Greece’s economic recovery and speculation the country may exit its bailout program this year are coinciding with strong risk appetite, driving down borrowing costs.
“Greece has been one of our strongest views in 2017 and 2016,” said Alberto Gallo, a portfolio manager and head of macro strategies at Algebris Investments. The firm has cashed out on some of its positions even though it continues to favor the trade, he said.
Greek bonds are maintaining a rally that gathered force in December, after they reached pre-bailout yield levels as the nation reached a deal with its creditors and concluded a debt swap. The yield on the Greek benchmark bond has sunk to its lowest since 2006 and about half a percentage point short of all-time lows of 2005.
Germany’s prospective governing coalition will likely spur greater euro-area cohesion and an uptick in federal spending that would further boost Greece’s credit profile, Gallo said. “This is and has been our base case, and it isn’t priced in.”
In this scenario, the yield spread to German obligations could tighten to as little as 250 basis points, Gallo adds.
That said, Greece’s debt market remains low on liquidity. For example, banks trading its current 10-year bond are asking about four basis points more than their bid yield on average, compared with 0.2 basis points for similar German debt, according to prices compiled by Bloomberg.
With the European Central Bank’s extraordinary stimulus pushing yields on so many government notes to negative levels, Greece stands out again in 2018.
“The Portugal two-year yield has also fallen below zero, so for some investors, Greece could be an option to realize some positive performance with debt measures and quantitative easing in place,” says Jeroen Blokland, portfolio manager at Robeco Nederland BV, the Dutch asset manager.