Published October 14, 2012
LONDON – Three years of crisis in the euro zone have thrust the once-sleepy government debt market into the public spotlight and transformed the way bonds are viewed, valued and traded.
Huge debts run up by governments since the euro's creation in 1999 have turned the bond market, which financed a decade of fiscal excess using its huge pool of faithful investors, into an arbiter of economic policy capable of fracturing the euro zone.
With those investors now far choosier, once arcane movements in bond yields have become the main indicator of the euro zone crisis and the borrowing costs of struggling countries such as Spain determine whether they have to be bailed out.
As a result, government bond traders have emerged from the shadow of the credit market, where private debt is raised and traded. This market had generated huge profits and drawn all the dealing room kudos over the previous decade due to a boom in complex, mortgage-based debt instruments - the very business that led global markets into the abyss.
"We're no longer seen as second class citizens when compared to credit. We're as much at the forefront of helping clients successfully navigate one of the toughest markets in a generation," said Carl Norrey, head of rates securities at JP Morgan in Europe, the Middle East and Africa, who oversees the bank's government bond trading.
The challenge is that investors now believe wealthy nations countries can default on debt, just like home owners and firms.
That shift began when a new Greek government revealed the disastrous state of its public finances in 2009, forcing investors and traders to rip up their assumption that bonds sold by any euro zone country were of roughly similar quality and risk free.
In the chain reaction witnessed since then, Greece has effectively defaulted on its debt, investors have abandoned Ireland and Portugal and, despite a series of previously unthinkable central bank measures, Spain is teetering on the brink of becoming the bloc's next state to seek a bailout.
As a result, the gap between the highest and lowest yielding euro zone government bonds - those of Germany and Greece - has widened to 17 percentage points from only a quarter of a percentage point five years ago.
Traders can therefore no longer rely on making money by dealing large volumes of low-commission trades that capitalize on small pricing distortions.
To survive at an investment bank these days, once specialized bond traders need much broader knowledge of the countries on which they concentrate, ranging from government and private debt to day-to-day political developments.
This is particularly the case for nations on the euro zone's "periphery" such as Greece and now Spain.
Morgan Stanley merged its peripheral government bond and credit trading units in 2011 to adapt to these changes, said Angelie Moledina, who co-heads rates and government bonds trading at Morgan Stanley in London.
At JPMorgan's London offices, traders have switched from specializing in all euro zone bonds with a particular maturity to become experts in all debt issued by a single country.
How traders work has also changed. Deals must be carefully timed to get the best price from volatile markets, where there are fewer buyers and sellers than half a decade ago.
Before the crisis erupted, money was made or lost on moves of one hundredth of a percentage point - one basis point - or less. Now, much larger swings happen daily and government bond dealers have to seek calm outside work, as their colleagues on traditionally more volatile markets have long had to do.
"Three years ago, a 10 basis point move was quite stressful. Now it becomes a fact of life - you adjust your positions accordingly and learn to live with it," said Guillaume Amblard, global head of fixed income trading at BNP Paribas. "At the end of the day you need to find ways outside of work to keep zen."
That can be hard when prices are more sensitive to political announcements at any time of day or night than to the scheduled economic data which once chiefly moved the market.
For example, Italian bond yields fell almost a full percentage point on December 5 last year after the government in Rome announced sweeping budget reforms, only to rebound fully in the next three days because expectations that the European Central Bank would buy its bonds subsided.
Traders typically sit behind banks of six to eight screens juggling price watching with scanning for market moving news.
One trader at a European bank, who declined to be named, said he monitors feeds from five different news agencies as well as continuously checking websites and social media feed Twitter.
This is a far cry from the days before the crisis when lunches sometimes stretched long into the afternoon and traders left the office minutes after markets shut, virtually switching off from news headlines until the next day.
Bigger price moves can mean bigger profits, but can also inflict huge losses which devastate investors' portfolios. This has prompted many investors to quit the worst-hit euro zone bond markets and changed the way traders work.
The fewer buyers and sellers there are, the less liquid the bond market becomes.
This exaggerates price swings and forces traders to break up big single trades into smaller amounts that will be bought or sold gradually during the course of a whole day to avoid moving prices, rather than with a single click or phone call.
The human touch has therefore become more important. While trading in financial assets has generally been moving towards offering and accepting prices on a computer, traditional over-the-phone transactions proved an invaluable way to get deals done at crunch points in the crisis when liquidity almost dried up.
"One day in one of the (peripheral) benchmark government bonds you could do a 100 million (euro deal) without too much trouble and then the next day 20 million would be as much as you could do without moving the market," said Nick Robinson, head of fixed-income trading at Schroders, a global asset management firm.
The importance of the bond market and its traders has grown as gyrations in government debt trigger huge swings in other asset classes and spill well beyond the euro zone borders.
In March, when the ECB poured a trillion euros of long-term loans into banks to tackle the crisis, the Australian and New Zealand dollars rose. And when political deadlock in Greece looked like ending in a chaotic default, European stocks tumbled 2.6 percent in one day.
Movements in bonds issued by troubled euro zone states have tracked the general mood of investors throughout the crisis.
"In moments of stress, Spanish and Italian bond yields have become the new fear index, it's the best indicator you can get," said David Thebault, head of quantitative sales trading at Global Equities in Paris.
Their elevated status has helped many bond traders keep their jobs while other desks cut back on numbers.
Fixed income trading - the broad category that includes sovereign debt - has not escaped job cuts, but most of the government bond trading desks at big banks have survived intact. Some banks, such as Nomura, have even expanded.
Those who have led the industry into its new age are sure of one thing - bond traders must keep acquiring new skills.
"Maybe if you are just trading (German) Bunds you can churn out prices and trade the curve - but those days are numbered. That is the old dinosaur mentality," said Norrey at JPMorgan.
"People either reinvent themselves, adapt to the new skill set, and embrace what is needed to do the job better for clients, or they don't make any money."
With companies, households and budget cuts depending on governments' borrowing costs, moves in bond yields have taken on global importance, forcing politicians and the public to become familiar with the bond market vocabulary.
"Finally after 20 years my mother understands what I do," a bond trader at a second European bank told Reuters.
(Additional reporting by Blaise Robinson in Paris, editing by Swaha Pattanaik and David Stamp)