Clarissa Tan

Bondholders are sheep — and they’re flocking out of the euro pen

Bondholders are sheep — and they’re flocking out of the euro pen
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Sweden’s Anders Borg (Fraser’s favourite finance minister) is wrong, says Citigroup. Bondholders and deposit holders are not like wolves, as Borg has made them out to be. They’re more like sheep — and currently they’re baa-a-a-cking out of the eurozone pretty quickly.

We all know that money's leaving the Continent — but how much and how rapidly? Citi’s credit strategist Matt King, basing his analysis on imbalances in TARGET2 (the euro area’s main payment settlement system) relative to eurozone countries’ current accounts, has come up with a few interesting observations.

— Since mid-2011, Spain has suffered private-sector outflows of €100 billion, and Italy €160 billion (or a tenth of their respective GDPs), King estimates. Both countries are likely to see further haemorrhaging of €200 billion each, and the speed of outflow is likely to quicken due to economic deterioration, ratings downgrades or a Greek exit. These estimates do not account for domestic deposit flight.

— In Greece, Ireland and Portugal, foreign deposits have fallen by an average of 52 per cent, and foreign government bond holdings by 33 per cent, from their peaks.

— Capital flight from Greece, Ireland and Portugal is impervious to market moods or movements, continuing steadily even during periods when the economic situation seemed more stable (such as the second half of 2010 in Portugal and in 2011 in Ireland). ‘Once begun, it does not stop,’ says King, pointing out that the LTRO-driven rally in Spain and Italy did not stem outflows either. ‘It’s almost as though a switch has been tripped.’

This switch-tripping tendency, says King, is because bond and deposit holders are by nature ovine. ‘Bondholders are not at heart the wolf pack Swedish Finance Minister Anders Borg famously made them out to be,’ says King. ‘Sheep, or perhaps wildebeest, would be a more accurate description.’

Bondholders and depositors graze quietly upon their coupons or interest payments, relying on others — such as rating agencies — to warn them of oncoming fundamental risks. ‘Once the flock has been disturbed, though, it can run quite quickly’ — and it’s almost impossible to get it to turn back.

Where is the flock headed, though? Citi’s research note does not cover this aspect, but George Osborne and Mervyn King are probably hoping the sheep will make their way to UK pastures and start grazing on gilts.