Bond market set for volatile week

 A trader walks next to a displays showing market indices at Madrid's bourse, Spain, June 30, 2015.
A trader walks next to a displays showing market indices at Madrid's bourse, Spain, June 30, 2015. PHOTO: REUTERS

LONDON (BLOOMBERG) - With Greece divided as it heads into Sunday's referendum on austerity, one thing looks certain: The bond market is set for another volatile week.

Price swings in European bonds approached the highest level in three years before the July 5 vote, in which Greeks will decide whether to accept the reforms demanded by creditors as the cost of a bailout.

A poll commissioned by Bloomberg showed 43 per cent intended to vote "no" to the proposal, with 42.5 per cent backing a "yes" result. "We could see large market moves on Monday as the outcome looks very uncertain," said Mark Dowding, a London-based partner and money manager at BlueBay Asset Management. "Even if there's a 'yes' vote, there remain many political obstacles to Greece securing a new bailout package. A 'no' vote, and markets will react in a risk-off fashion."

A "yes" result is likely to spark a rally in bonds from Europe's most-indebted nations and a selloff in its safest assets such as German bunds, strategists said.

A rejection of creditors' terms would probably mean the opposite because it may push Greece closer to exiting the euro area.

Bunds, the euro area's benchmark sovereign securities, have been supported since Greek Prime Minister Alexis Tsipras called the referendum last weekend. The decision has meanwhile weighed on Spanish and Italian bonds, which declined in the week before rallying on Friday. Even so, contagion to the bonds of these higher-debt euro- zone nations has thus far been limited amid optimism the European Central Bank will be able to contain the fallout from the mounting crisis.

Spanish 10-year bond yields rose 10 basis points, or 0.1 percentage point, last week to 2.21 per cent, though that's still about five percentage points below their euro-era high of 7.75 per cent in July 2012.

Italy's 10-year bond yield jumped 10 basis points last week to 2.25 percent, while that on German debt dropped 13 basis points to 0.79 per cent. "Most investors are trying to stay neutral versus their benchmark before the vote," said Luca Cazzulani, senior fixed- income strategist at UniCredit in Milan. "The higher the margin of the 'yes' vote, the more risk-on trade we're likely to see."

Euro-area sovereign bonds handed investors a 5.4 per cent loss in the second quarter, the worst performance on record, according to Bank of America Merrill Lynch's Euro Government Index, which tracks data back to the end of 1985. The declines were led by an 18 per cent slide in Greek securities, with Spanish bonds losing 6.1 percent and German bonds sliding 4.5 per cent.