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Bond Vigilantes Say EU Needs Better Plan for Greece


Feb. 18 (Bloomberg) — European Union leaders are failing to persuade bond investors that Greece can fix its budget.

The yield on Greek two-year notes has remained above 5 percent, the highest in the euro zone, even after officials urged the nation this week to reduce its deficit. The premium investors demand to hold the notes instead of benchmark German securities has held above 4 percentage points, the most since the Mediterranean nation joined the euro and more than 10 times its 35 basis point average the past decade.

After driving yields to the highest in 10 years, bond investors are keeping up the pressure on the EU to support Greece. Concern that the nation’s inability to narrow a deficit that is more than four times the EU limit will be replicated in countries such as Portugal and Spain prompted Societe Generale SA’s top-ranked strategist Albert Edwards to predict Feb. 12 that the euro region was poised to break up.

“The market has replaced the EU as the chief enforcer of fiscal discipline, and the movement in spreads is testament to that,” said Charles Diebel, senior interest-rate strategist at Nomura International Plc in London. “What the bond markets have done to Greece could be the salvation of Europe.”

The euro weakened 0.3 percent to $1.3567, bringing its three-month decline to 9 percent.

No Specific Measures

Investors who push up debt yields in an effort to alter government policy are known as vigilantes, a term coined in 1984 by economist Edward Yardeni, president of Yardeni Investments Inc. in New York. They were credited with forcing Bill Clinton to cut the U.S. deficit after he came into office in 1993, helping drive 10-year Treasury yields down to about 4 percent by November 1998 from above 8 percent in 1994.

“Fiscal rules are only as good as the political will to enforce them, and there hasn’t been much of that, especially during the good times,” said Nick Kounis, chief European economist at Fortis Bank Nederland NV in Amsterdam.

Greek two-year yields rose the most in almost three weeks on Feb. 16, when euro-region finance ministers stopped short of announcing specific measures to help the country. EU Economic and Monetary Affairs Commissioner Olli Rehn said after their meeting in Brussels that the bloc has “ways and means” to safeguard stability in the euro area.

Greece said last year that the deficit would be 12.7 percent of gross domestic product, compared with the EU ceiling of 3 percent. Prime Minister George Papandreou’s Dec. 14 pledge to take “radical” action failed to stop Moody’s Investors Service and Standard & Poor’s from cutting the country’s credit ratings.

Shrugging off Papandreou

Yields rose even after Papandreou announced a plan on Jan. 14 to cut the deficit by 10 billion euros ($13.7 billion), forcing further concessions two weeks later when he promised to boost the retirement age and freeze public sector pay. That reversed a pledge he made in last year’s election.

While the vigilantes are punishing fiscal transgressors in Europe today, they were largely silent for much of the past decade as governments flouted the EU’s rules. The spread between Greek and German 10-year yields averaged 19 basis points in 2004 even as the Mediterranean nation’s budget deficit was 7.5 percent of GDP, the biggest in the region.

“The experience of the past 10 years shows that markets can be ignoring these issues totally until they suddenly wake up and turn violently against fiscal offenders,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London. “Market discipline is important and necessary, but sudden shifts in sentiment in the bond market can be equally devastating.”

Limits Exceeded

Euro-region nations have exceeded the 3 percent limit on their budget deficits 44 times since the currency was introduced in 1999. Greece has been the biggest offender, as its deficit rose above the ceiling in eight of the nine years since it joined the euro in 2001. Italy broke the rule six times. Portugal, France and Germany flouted it five times.

All 16 countries that use the euro will post budget deficits above 3 percent for 2009. Ireland will have a 12.5 percent shortfall, and Spain will have an 11.2 percent gap, according to European Commission estimates.

Greek “yields seem fair to me,” said Bob Treue, founder of New Jersey-based Barnegat Fund, ranked among the top three hedge-fund performers in fixed income last year with a 132.7 percent return, according to Bloomberg calculations. “We don’t have a position in Greece, long or short.”

Rules ‘Appropriate’

Current rules and instruments are “appropriate,” EU Economic and Monetary Affairs spokesman Amadeu Altafaj said in response to questions from Bloomberg News. “The issue at stake is not the rules and the instruments but the non-compliance to these rules.”

If the EU fails to convince markets that it can solve Greece’s difficulties, investors may turn their attention to its neighbors, according to Mark Schofield, head of interest-rate strategy at Citigroup Inc.

“Spain, Portugal, Italy and Ireland might not be a problem now, but if the market starts pushing their spreads wider, and put them in the situation where they are forced to fund their deficits at much more onerous levels, then you will see a lot more pressure for a pan-European solution to the problem,” he said.

Yields on the debt of other peripheral euro-region countries also rose in recent months as investors bet the budget crisis wasn’t limited to Greece. Portuguese two-year yields touched 2.72 percent on Feb. 4, 1.65 percentage points above Germany’s level and an almost 13-year high.