European bond market: Things to look out for

Right now, 10-year Greek bonds are offering a yield of 20.99 per cent. This is obviously an extremely high yield, but certain factors must be taken into account.

It is clear that the last round of “Greek bailouts” was a very short term Band-Aid and that the Band-Aid has already come off. Although this may be cause for concern, the world economy would not be able to withstand the Greek economy defaulting, and thus would not allow it to do so.

Assuming that this is true, bondholders will likely have to take a cut on their yield. Even if the cut they take is 50 per cent of the initial yield, they are still getting a 10-year bond with a yield of 10.5 per cent.

Negotiations for another bailout have commenced, and a decision was expected by 5 September, but was later postponed until October. Elsewhere in the continent, both Italian and Spanish 10-year bonds hit all times European highs in the first week of August, with both of the yields being set at over 6 per cent.

The European Central Bank (ECB) started buying Italian and Spanish government bonds on the secondary market on 8 August to ring fence the euro zone's third- and fourth-largest economies from a spreading debt crisis in the region.

Currently the Italian 10-year benchmark is set at a very attractive 5.46 per cent, and the Spanish 10-year benchmark is currently set at 5.14 per cent. Both bonds have experienced increases in their purchases, further dictating that the purchases from the ECB are having a positive effect.

With the support received from the ECB in controlling the fluctuation of the yields, confidence is high that demand for the bond will increase over the coming month and thus could be a good investment for a slightly riskier investor.

One bond that is definitely worth looking out for over the coming months is the M&G International Sovereign Bond.

Over the last 3 months, the bond’s performance has been 8.78 per cent, which is more than 8 per cent above than the sector. The current yield on the bond is 1.49 per cent. It has also consistently outperformed the sector quite comfortably over the last 5 years.

Over the period, the bond has also constantly ranked in the top three of its sector. 50 per cent of the bond’s holdings are constituted between Germany, Norway, Sweden, Poland and the United States, with the holdings in Germany and the US accounting for the majority.

This is important to note because sovereign credit default swaps (CDS) are at the forefront of everyone’s minds as investors monitor the continuously frail situation in Europe. Although the risk of default has reached an all time high in Europe, there has been good news out of the US.

A recent pick-up has been experienced in US CDS during the issue of the debt ceiling, but the cost for protection against default has decreased substantially since then.