Greek bond yields up to pre restructuring level

The "troika" of the International Monetary Fund, the European Commission and the European Central Bank interrupted a visit last year due to a lack of progress in discussions with Greek authorities. Since then, the Greek economy has shown signs of significant improvement.

Its budget surplus for 2013 beat forecasts and its economy shrank less than the government or its lenders expected - achievements which should lead to the disbursement of loans held up since September, analysts said.

Sources directly involved in the talks told Reuters earlier this month that differences over plugging a 1 billion euro funding gap for this year had largely been bridged.

Greek 10-year yields last stood at 7.58 percent, about 10 basis points above their lowest levels since a March 2012 debt restructuring, which were hit last week.

“Greece has made progress ... with the attainment of a primary surplus and early signs of stabilisation in the economy," said Dennis Shen , economic associate at Alliance Bernstein.

A spike in trading volumes in Greek bonds and a tentative resurgence of debt insurance instruments represented further signs of healing in a market once at the mercy of so-called vulture funds reputed for seeking high returns in collapsed assets.

Volumes in the first five weeks of the year stood at about 546 million euros, about 36 percent of the turnover for the whole of 2013 and almost matching 2012's annual volume, Greek Central Bank data showed.

That indicated a broader group of investors than just domestic banks and high-risk hedge funds were interested in Greek bonds while volatile trading during this year's emerging market tensions suggested investors with mandates in the developing world were holding some Greek bonds as well.

"Some of the real money has gone in there on the back of the European recovery story - lots from New York, London and Europe ," said Gabriel Sterne, economist at distressed debt brokerage Exotix.

This year has also seen the re-appearance of prices of Greek credit default swaps, last quoted at roughly 490 basis points, although data provider Markit said they were for the moment indicative. The market effectively collapsed after Greece restructured its debt.

Once CDS trading picks up, investors will be able to hedge their exposure to Greek bonds and may be more willing to hold them, analysts said.

"It's all related to investors regaining interest in trading (Greek) bonds," ING rate strategist Alessandro Giansanti said.

WARNING SIGNS

There remained warning signs, however Reuters indicates. Greek 10-year yields are still higher than those on 30-year bonds - an inversion that usually occurs in distressed debt markets when investors price in a high risk of default.

This suggests that despite the improved outlook, some investors still fear they may not be fully repaid.

The ruling coalition in Greece has a narrow three-seat majority in parliament and a collapse might pave the way for anti-bailout party Syriza to come to power.

Analysts warn any more brinkmanship between Athens and its lenders could further erode the coalition, especially with European Parliament elections looming.

Senior European officials have ruled out another debt restructuring in Greece, but analysts say all bets are off if Syriza - ahead in polls - comes to power.

"The main risk in Greece is political," said Shen at Alliance Bernstein.

Greek 30-year yields fell 4 bps to 7.23 percent.

By comparing bond prices with where they would be if they paid similar coupons to low risk German Bunds, ING estimates the market sees a roughly one in three chance of default. Markit's standard calculations based on CDS spreads show a similar default probability.

"Clearly the yield curve and the absolute level of yield would imply an elevated risk of default," said Sohail Malik, lead portfolio manager for the ECM Special Situations hedge fund, which has exited the market after the sharp drop in yields.