“Buy Greek government bonds,” the debt strategy team at Morgan Stanley (NYSE:MS) said in May. “This is one of our top fixed-income trades of the year,” added Paolo Batori, the bank’s global head of sovereign strategy, to hammer the point home.
At the time, the recommendation was surprising, not so much because the Greek government’s bonds were seen as unpalatable, but because they had already rallied significantly. Batori argued that the broader market’s expectations for the country’s economy were too gloomy and that the risk of the country leaving the euro zone had all but been adverted, saying at Morgan Stanley’s Macro Ideas and Insights Forum that the bonds were one of the bank’s “top fixed-income trades of the year.”
But times have changed, and Morgan Stanley has lowered its rating on the bonds.
Renewed political uncertainty brought on by problems the Greek government had meeting the deeply unpopular terms of the country’s bailout, along with news that Greece’s junior coalition government partner withdrew from the cabinet, made investors jittery. As a result, investors bid Greek government bonds to their lowest level in two months on June 21. At the time, markets were already nervous because of the U.S. Federal Reserve’s announcement regarding the potential unwinding of its monetary stimulus program. Weeks of tough trading followed.
On Tuesday, The Wall Street Journal reported that Morgan Stanley ended its long-standing recommendation to buy Greek debt, a marked reversal on the part of the bank’s strategists, who had said that the bonds were one of its “top trades.”
While signs of political instability have been evident in full force inside Greece, the government’s problems were not what primarily prompted the bank to change its views on the investment. For once, the problems were external, according to Batori and his fellow strategist Robert Tancsa.
Risky assets, such as government bonds, have suffered as investors grow ever more concerned about the upcoming scaling back of the U.S. central bank’s asset purchases. Even more to the point, the general bond market risk appetite has been reduced by the political crisis in Portugal and subsequent bond sell-off.
“The repricing of the broader risk premium has an indirect implication on fair value [of Greek bonds],” the Morgan Stanley strategists wrote in a note to clients. Greek 10-year bonds have seen yields climb as high as 11.7 percent from the 8.15 percent recorded in late May. The bonds now change hands at a yield of 10.5 percent.
Morgan Stanley calculated that the fair value of the Greek government bond strip — which includes all bonds, from those maturing in 2023 to those due in 2042 — at 47.5 percent of the bonds’ face value, a decrease of about five percentage points from previous estimates. That yield is close to current market levels, inducing the bank to lower its recommendation on Greek debt to neutral. If a debt restructuring takes place, the figure will fall to 45.8 percent.
Still, it will be difficult for investors to realize fair value on Greek government bonds for a while. “We are concerned that lack of positive idiosyncratic momentum and sustained global market volatility may keep bond prices under pressure,” the strategists wrote.
Follow Meghan on Twitter @MFoley_WSCS