Friday, July 13, 2012

A Year of Bond Yields

It is now a year since the Irish government bond 9-year yield as calculated by Bloomberg peaked at 15.5%.  As of today it is just under 6.3%.

Bond Yields 1Y 13-07-12

The peak last July was the result of uncertainty in the run-up to the July 21st EU Summit.  There were strong rumours that Private Sector Involvement (PSI) and bond writedowns would be a feature of all bailout programmes.  Greek and Portuguese yields shot up similarly.

As it was, PSI was limited to Greece while Ireland and Portugal were ‘rewarded' with significant reductions in the interest rates on their EU loans.  Irish yields dropped precipitously in the weeks after the summit, in part driven by the decision to limit PSI to Greece and also because of purchases by the covered banks who used some of the recapitalisation money they received last summer to buy Irish government bonds.

This has proven to be a good investment for the banks.  The most recent Money and Banking Statistics from the Central Bank show that the covered banks holdings of Irish government bond are worth €16.3 billion.

The yields fell to around 8.5% by early September and stayed around there until Spanish  borrowing costs exploded in late November.  The Irish 9-year yield briefly threatened to return to the 10% mark, but the jump in late November was followed by a steady decline to 7% over the next two months.  This fall began a couple of weeks before the ECB launched its Long Term Refinancing Operations (LTRO) that provided close to €1 trillion to eurozone banks.

For the next three months the yield hardly budged from 7% before a step-up to 7.5% in mid-May following further Spanish uncertainty.  The announcement at EU summit on the 29th June last of possible direct bank recapitalisation by the ESM and the mention of some retrospective action in the case of Ireland saw the yield drop to 6.3% where it has been since.

One thing is clear over the year: changes in Irish government bonds yields have very little to do with domestic developments.  All the big changes over the past year have been driven by external or official events.  Economic data in Ireland has largely been moribund over the period with no discernible upward or downward pattern.

Uncertainty was of the biggest determinants of the yields.  Uncertainty about the size of the hole in the banks pushed Ireland out of bond markets and into an EU/IMF rescue programme.  Uncertainty about the possibility of PSI pushed the yields nearly 16% last July.

There is still a good deal of uncertainty: will the budget deficit continue to fall?  what do the recent EU statements mean for Ireland?  where will the growth come from?  We must wait to see what the answers will bring.  It will take some more ‘good news’ to bring the yields to 5% and lower which makes sustainable borrowing costs more likely.

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