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What is the message from Greece’s bond market?

The International Monetary Fund’s description of Greek debt as potentially explosive has left negotiators in Brussels struggling to bridge the differences between Athens and its creditors before time runs out to avert default.

With creditors unwilling to release the next tranche of bailout money needed to keep the country afloat, Greece is facing €7bn of debt redemptions in July that it cannot afford.

Investors appear to have given up on a resolution being found before Europe’s busy election calendar begins, prompting a sell-off in Greek debt that has pushed the yield on two-year bonds to an eight-month high.

Yet the tumult is mild when compared with previous crises. To understand the message Greek bonds are delivering about the country means understanding the market’s oddities.

Are Greek bonds in crisis?
Greece’s looming debt deadline in July includes €2bn of repayments on a bond the country does not have. Meanwhile, the outlook for growth and debt sustainability remains uncertain, says Alberto Gallo at Algebris Investments. “Greece cannot grow out of its debt problem.”

The bond in question, however, is being traded at about 97 cents in the euro, while a 2019 bond is trading at 91 cents in the euro. The market rule of thumb is that a country about to default will see bond prices drop to 40 cents in the dollar (or euro).

What’s more, the Bank of Greece claims that Greece’s 10-year borrowing rate is 7.85 per cent. That is high by European standards but nothing like the rates Greece faced during the eurozone debt crisis in 2010-12 when 10-year rates reached 35 per cent.

But the prices do not necessarily mean that investors are unconcerned. Instead, it reflects the fact that Greek bonds do not trade frequently, meaning that quoted prices may not be a true reflection of the price investors would sell them at if they could.

According to Bank of Greece, €28m of Greek bonds were traded on the electronic secondary market in January, and on some days there was no activity at all. To put that in context, €19bn of German Bunds are traded in secondary markets every day.

Why is the market so small?
While Greece has a punishing debt burden of €323bn — and the second largest ratio of debt to GDP in the world after Japan — outstanding Greek bonds account for just €36bn, a tiny fraction of the total.

This is the result of the country’s vast debt restructuring in 2012, when bondholders accepted a large writedown on their investments and the majority of Greek debt swapped hands from the private sector to the public sector.

Compounding the situation, Greece has been frozen out of capital markets since 2014 as investors remain wary of the government’s ability to meet debt obligations. Global markets certainly have no intention of lending Greece the money it needs to make payments this year and avert default.

What bonds are outstanding?
You can think of Greece’s bond market in two parts. The first is what remains of the country’s 2012 debt restructuring when banks and other private creditors agreed to a steep write-off in the so-called private sector involvement (PSI).

There is about €30bn of PSI bonds with maturities between 2023 and 2042, plus about €1.6bn of bonds held by investors who refused to take part.

Commercial banks think of these 20-odd PSI bonds as a strip, rather than individual securities. Instead of buying into one, investors tend to buy portions of each, which is why describing the yield on a PSI bond that matures in 2027 as Greece’s 10-year benchmark borrowing rate is misleading.

The other part of Greece’s bond market is the €4.5bn of debt it sold in 2014 when the government was convinced that its crisis was in the past.

First came a five-year, 2019 bond. Then a three-year, 2017 bond. Greek banks were later able to exchange some short-term debt for government bonds, bumping up the outstanding sum.

After a huge bailout from the IMF and Europe, investors bet that the country’s prospects were improving and the price of its bonds would go up, especially if the European Central Bank launched a bond-buying scheme as seemed likely.

Things did not work out this way. Greek bonds were not included in ECB bond-buying and the country has repeatedly edged into crisis.

Who owns Greek bonds?
The bond market may be a no-go area for many investors but there are a few large mainstream bondholders that remain involved. Carmignac, Natixis and Pimco are among the investors in Greek bonds, according to Bloomberg data, along with Greek banks.

A number of specialist distressed debt investors have also built up positions in Greek debt since 2015, when bonds were trading below 30 cents in the euro, according to one banker who has worked with the country. If the country defaults, this group may try to hold out for full repayment.

Why do the bonds matter?
Greece’s optimism three years ago has come back to haunt it — and the investors who believed in it.

In July, more than €2bn is owed to private sector creditors who bought into the country’s recovery story in 2014, along with more than €3bn due to European creditors. Greece can afford neither without fresh bailout money.

Creditor brinkmanship has been resolved at the eleventh hour before — and may be again. Erik Nielsen at UniCredit, for example, says he believes there will be a deal before July.

But the country’s long-term goal of debt sustainability is to regain access to international debt markets. With each new debt crisis, that comeback is looking increasingly far away.

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