Thursday, February 18, 2010

PIIGS Go To Market.

Story Highlights:

•PIIGS countries Ireland, Spain, and Portugal held successful sovereign bond auctions this week—all were oversubscribed.

•Over and undersubscribed auctions are normal—the process of price discovery in primary markets is inevitably bumbling.

•Any reasonably credit-worthy issuer can sell bonds for the right price; the question is whether the debt cost will be more than the issuer can bear.

•Default by one or more of the PIIGS is still a possibility, but the fact folks are willing to buy long-term bonds at historically low rates seems to indicate investor confidence.

Just days after euro-jitters were whipped into a frenzy by a poorly priced (and thus undersubscribed) Portuguese bond auction, fellow PIIGS (Portugal, Ireland, Italy, Greece, and Spain) countries Ireland and Spain held successful sovereign bond auctions—raising €1.5 billion and €5 billion in 10- and 15-year bonds, respectively. Additionally, Portugal repriced its debt at another auction—this time easily selling the lot.

It’s becoming increasingly clear Portugal’s initial undersubscribed auction wasn’t an indication of imminent default; rather, the yield was simply below prevailing market rates and not commensurate with the debt’s risk. Somewhat ironically, Portugal’s follow-up bond sale offering prices above market interest rates was (surprise, surprise) massively oversubscribed. The process of price discovery in primary markets is inevitably bumbling—over and undersubscribed auctions are normal, typically resulting from too-high or too-low offered interest rates. In other times, when the spotlight’s not so blinding, such auction action would raise fewer hackles. Instead, nervous investors read too much into a mispriced auction.

But the real question at hand isn’t whether a country can sell its debt—any issuer can sell bonds for the right price. (PIIGS countries might be risky, but a higher yield can clearly still attract plenty of buyers.) The question is whether the debt cost will be more than the issuer can bear. It’s notable then that even though investors are demanding higher yields right now, those yields are still near all-time lows for the PIIGS. And that investors are willing to buy 10- and 15-year bonds at those relatively low rates registers, in part, a vote of confidence the PIIGS won’t default—or, perhaps more accurately, won’t be allowed to default. The EU has shown strength amid the drama—voicing strong support and approving Greece’s austerity measures, while simultaneously setting a tight deadline for action and revoking Greece’s voting rights for one EU meeting (a first for the EU, and a sign the union has teeth and is willing to use them).

And it wouldn’t necessarily be the end of the world should the EU decide against aid. Country defaults are hardly a new phenomenon—markets have survived wave after wave throughout history. And the PIIGS combined make up only 7.5% of world GDP.* Of course, a risk worth watching would be any knock-on effects a default would have on the EU and euro (a strong argument for EU intervention). Thankfully, the PIIGs’ fate is far from sealed, and increasingly it seems European policy flexibility and waning investor jitters may win the day—allowing these particular PIIGS to fly another day.

* IMF; based on 2008 estimates.

 Courtesy: Fisher Invesments.

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