There is a lot of focus every day on this site and in the media on the ten-year bond rate rate and Bloomberg’s web page showing the yield on this bond is regularly linked to. However, the movements in the ten-year bond only tell part of the story of the past couple of weeks. There have also been dramatic movements in the shorter-term bond yields.
The four-year bond yield, which had been about 3% in early June, reached 5% in late October and, as I write, stands at 8.34%, not so far short of the 8.92% prevailing on the ten-year bond. This suggests that the market is pricing in a debt restructuring in the next few years. (See this earlier post for a discussion of the relationship between bond yields and default probabilities.)
Even more disturbing have been the movements in the two-year bond. The yield on this bond had been about 2% as recently as June. It started November at 4% and, as I write, has now soared to 6.66%. Given that pessimists are likely to be assuming that Ireland will be borrowing from the EFSF in two years time, the implicit pricing in of a high probability of a debt default\restructuring as early as 2012 strikes me as unwarranted. But it illustrates the scale of the current negative sentiment towards Ireland in the bond market.
As of yet, the government has not been able to turn this sentiment around. An optimist might argue that passing the budget, resolving the political uncertainty via a general election and the emergence of solid evidence of a return to sustained growth might, together, achieve the required improvement in sentiment. A pessimist would argue that it’s too late.
Whoever’s right, the government needs to at least play it’s role in providing the first step in attempting to make the optimistic scenario come about by passing the upcoming tough budget. If it could achieve that goal, then after that point, there’s a strong argument that the best thing the government can do is deal with the second element of the optimistic scenario by resolving the political uncertainty as early as possible with a January general election. As to whether the third element of the optimistic scenario—the emergence of growth—occurs, one could argue that this is largely out of the government’s hands at this point