Languid reaction to repeated faltering Greek negotiations suggests that the notion of ‘Grexit’ has long been taken into account……..
by Viktor Nossek, Director of Research of WisdomTree Europe
It is German Bunds, not Greece, which remains at the epicentre of souring sentiment in Eurozone bonds.
Heightened bond market volatility amidst a resilient euro reflects improving economic conditions in the Eurozone, defying fears of contagion risk from Greece.
High sensitivity of Italian 10Y BTPs to German 10Y Bunds offer investors a leveraged play on the European bond market.
Bearish positioning in Eurozone fixed income may be warranted. Leveraged short ETPs tracking German Bunds and Italian BTPs are efficient investments to play the theme.
The languid reaction to the Greek debt crisis not only suggests that ‘Grexit’ has long been priced in, but also reinforces the notion that the bond volatility in European fixed income markets earlier this month was driven primarily by ‘irrational’ low yields in German Bunds (see last week’s macro alert for more detail).
‘Eurozone bond yields sensitive to Bunds, insensitive to Greece’
Since the end of the financial crisis, the sentiment in Europe’s bond markets has increasingly been led by the strength of the German Bund and less by the weakness of Greek sovereigns. Following ECB’s QE, this has become more apparent given the diverging paths of bond yields between Greece and the rest of the Eurozone. This is not to say that on a short term basis sentiment in Greek sovereigns will not affect bond yields elsewhere in the Eurozone, particular in light of the repeated on-off debt negotiations between Greece and the Troika driving sentiment and provoking opportunistic positioningBut while correlations can be high, it is the sensitivity between bonds, in terms of their mutual impact on yields that really matters to investors, especially since while bond yields can be highly correlated, one can be insensitive to the other. As indicated in the chart, Italian 10Y BTPs have displayed a much greater sensitivity to German 10Y Bunds, with a beta coefficient of 2.3, than their Greek counterparts, which has a beta coefficient of 0.169. The insensitivity of yields between Italian 10Y bonds and Greek 10Y bond adds to the picture that Greece’s debt woes simply have not reverberated onto the peripheral Eurozone bond market.
Leveraged positioning on the Bund is how to efficiently play Eurozone’s bond markets
A disconnect between the ‘Grexit’ talk and the sentiment in the bond markets is also evident in the resilience of the euro, which has rallied to a monthly high against the U.S. dollar while European equities finished the week marginally higher. With negotiations between the anti-austerity Greek government and the Troika having dragged on for months, investors have had plenty of time to weigh up what a ‘Grexit’ means for the rest of the Eurozone. With Eurozone’s economy on sounder footing, any outcome is now unlikely to materially undercut it, given the extraordinary stimulus measures the ECB has put in place. Markets continue to shrug off the faltering talks between Greece and its creditors.
This presents an opportunity for investors to play Europe’s bond markets with a view on the German Bund and its irrational valuation, which suggests too much fear and crisis-like conditions being priced-in. Bond markets have experienced a sharp correction since April to date, with the 10Y German Bund rolling futures index down by 4.5%. Being highly sensitive to the German Bund, the 10Y BTP rolling futures index has seen an even steeper decline by falling 7.4% in the same period. 3BUS or 3BTS, which are 3x Short ETPs tracking the futures of 10Y Bunds and BTPs, respectively, have over the same period returned 13.8% and 24.4%, respectively. 3BUS and 3BTS offer investors a leveraged bet on the European bond market and an efficient means to tactically position bearishly amidst the heightened volatility in bond markets.