Hedge funds take bets against core euro zone bonds

Tue May 29, 2012 7:02am EDT
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By Laurence Fletcher

LONDON (Reuters) - Hedge funds are piling into bets against the bonds of core euro zone countries like Germany and France, signaling a growing fear that nations once considered safe havens could be dragged down by the crisis in peripheral states like Greece and Spain.

After a buoyant first quarter for markets, when fears over the euro zone debt crisis receded thanks to a 1-trillion-euro ($1.3 trillion) cash boost from the European Central Bank, hedge funds have been quick to make sure they don't miss out as concerns over the future of the single currency resurface.

Rather than bet on the likes of Greece and Spain, whose problems are now well documented, funds are shorting the bonds of core countries as a so-called 'tail hedge' - the purchase of protection against extreme events such as the launch of eurobonds, which would drive up the cost of borrowing for Germany, or even a break up of the currency bloc.

While such bets have so far failed to pay off - rising French bond prices drove yields to their lowest since September 2010 on Friday - hedge funds are targeting core countries because liquidity is better than in peripheral markets and they feel their safe-haven status has been exaggerated as the crisis elsewhere deepens.

"There's definitely a feeling the market is getting shorter (i.e. there are more short positions)," said one fund of funds manager who asked not to be named.

"There are new entrants in the bearish trade, some U.S. groups are trying to catch up after minimizing the importance of the European problem during most of Q1. There's a bit of a herding effect."

Shorting means borrowing a security in anticipation the price will fall, allowing the seller to make a profit by buying it back more cheaply in future.

Yields on 10-year bonds of several core countries have slumped this year, as investors hunt for alternatives to Germany, whose safe-haven appeal allowed it to sell 4.56 billion euros of bonds with a zero coupon last week.   Continued...