Investors in Greek bonds may be sitting on heavy losses, but for those brave enough last year to place bets on recovery in Ireland, the rewards have been substantial.
Irish sovereign debt has enjoyed one of the strongest rallies in bond markets since July, when Dublin, after a banking crisis that led to a bailout, had looked like it could follow Athens toward probable default.
Over the past eight months investors have become increasingly convinced Ireland is committed to reforms that will turn round its economy. Yields on government bonds, which have an inverse relationship to prices, have dropped sharply.
Yields on Irish nine-year debt last week dropped through the 7-per-cent level for the first time since the country was rescued by the European Union and International Monetary Fund in November, 2010.
Investors who bought Irish bonds when yields peaked at over 15 per cent in July, 2011, as the euro zone crisis intensified, and held them until now, are sitting on a 50-per-cent return on their investment.
Several big international investors bought Irish debt last year, including California-based Franklin Templeton Investments, which purchased at least $2.49-billion (U.S.) in bonds between May and November, 2011. Irish banks have also been active in the bond markets since the summer, pushing down yields to more sustainable levels.
"Ireland presented a very interesting market opportunity last year and some people have made a lot of money by investing in Irish bonds," says Donal O'Mahony, global strategist at Davy's Capital Markets, one of the main sellers of Irish government debt.
Irish bond yields began to decouple from Greek and Portuguese yields last July when EU leaders agreed to cut the interest rate Dublin was charged for bailout loans, saving the country €1-billion ($1.32-billion) a year in debt servicing costs. They also reassured investors that the "haircuts," or losses, proposed for Greek bondholders were an exception and other troubled countries, including Ireland, would pay their debts in full.
Ireland's return to economic growth in 2011 on the back of a booming export sector and the stabilization of its banks has done much to improve investor sentiment, even as the outlook for other countries has deteriorated. "Continued export growth has helped differentiate Ireland from Greece and Portugal, which are both considerably more reliant on their domestic economies for growth," says Michael Cummins at Dublin-based financial services firm Glas Securities.
Irish bond markets, moreover, have continued to outperform those of other peripheral euro zone economies since December, when the European Central Bank offered cheap three-year loans to head off a credit crunch for the continent's banks.
Indeed, Irish banks, like many other domestic banks in the euro zone, have bought their own sovereign debt to take advantage of the ECB's so-called longer-term refinancing operation, or LTRO. This is where banks can borrow from the ECB at 1 per cent and lend or buy sovereign debt for a much higher yield to make profits through the so-called "carry" trade.
This improved sentiment enabled Dublin last month to return to international bond markets for the first time since September, 2010, to swap €3.52-billion in government bonds. It is expected by analysts to continue to tap bond markets in the coming months.
Alan Wilde, head of fixed income and currency at Barings, says: "[Ireland]are the poster boys of debt reform. They have also made progress in sorting out their banking system. Most importantly, there is a strong view among some funds that Ireland will carry out and stick to reforms, unlike Greece and Portugal."
Ireland, though, is not in the clear yet. For a start, it has a small bond market, which means that just a handful of big funds deciding to sell could turn sentiment, and the direction of bond yields, quickly.
Second, the Irish still need to turn round their anemic economy. House prices are falling, which is a drag on consumer confidence and a worry for some investors. Its export-led recovery, moreover, could yet be knocked off course if there is a further deterioration, as many economists expect, in the wider euro zone economy.
A potentially divisive referendum on the proposed euro zone fiscal "compact" to impose public spending discipline could also undermine sentiment if the government is forced to hold a vote in the coming months. Mr. Wilde says: "There is still a lot that can go wrong for Ireland, not least a second big wave of risk aversion because of problems elsewhere in the euro zone."
Perhaps the biggest worry for Ireland is contagion, as troubles elsewhere knock sentiment across the euro zone. The spark for contagion could come from delays over the Greek rescue package or poor data out of Spain and Italy.
Padhraic Garvey, global head of rates strategy for developed markets at ING Financial Markets, says: "There have been some big funds that are now prepared to buy Ireland, but if sentiment deteriorates across the region, then Ireland could be taken down in a new wave of risk aversion."
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