Bonds May Be Losing Their Allure

PortfolioSecurity markets are bracing for losses today as euro-zone leaders continue to argue over how to bail out Greece. A rift has emerged between Germany and the?other 16 euro-zone nations over plans to shore up Greece with euro bonds.

A bond is a debt security issued by a government, state entity or a company that the debtor must pay with an interest or yield.? In the case of Greece, the yield or interest is high, at more than 15 percent, because of the looming risk of default after Standard and Poor’s recently downgraded the country’s debt rating to junk status.

At a meeting on Thursday, the EU is supposed to agree on guaranteeing Greek debt, but Germany is refusing to go along, arguing that the plan amounts to forcing tax payers of other countries to take on the national debt of Greece.

Both sides have a point, and investors are in a bind. There are high rewards for Greek bonds but there are also high risks. Hedge funds that trade bonds and loans are increasing bets that Europe?s sovereign debt crisis will spread to Portugal, Spain and Italy.? As a result, investors are increasingly asking for higher yield to take on the mounting risk of default.

Bonds have long been used as a global safe-haven for investors shunning risky assets. They serve as a benchmark for market interest rates and investment portfolios. But the inability of euro zone officials to agree on a plan to help Greece, along with the U.S. deadlock over debt ceiling talks, have heightened the risks of default, with growing potential losses to investors. As a result, bonds are losing their allure.

In Greece, Portuguese and Ireland, most of the bondholders or creditors are foreign investors who are more likely to be spooked at the slightest sign of trouble, while Italian and Spanish bondholders are mostly local investors who have a higher tolerance level. Still, analysts say there’s a pressing need for political leaders and policymakers to act quickly to prevent the problem from getting worse.

“I don’t think the European Central Bank, and much less individual Euro Zone central banks, except maybe Germany’s Bundesbank, can stand a chance against a wave of big fund managers who, when acting like a herd, can be as formidable as a tsunami because these guys can move billions in and out of regions in minutes…The bet’s now on for a domino effect among the PIIGS…If Spain falls, all hell breaks loose,” said one analyst, using the term that refers to Portugal, Italy, Ireland, Greece and Spain.

Last week, the European Union’s second round of bank ?stress tests? appeared to calm some nerves as only eight out of 90 banks failed the tests. Still, confidence remained shaky, with many questioning the stringency of the criteria.

Some hedge funds have stepped up trading in mobile-phone, utility and toll-road companies in the heavily-indebted euro zone countries, expecting their governments to be forced to slash spending to pay off lenders, slowing growth and reducing discretionary consumer outlays.