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May 30, 2017

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Eurozone gold rush eyes southern eurobonds

PARIS -- The badly tarnished countries of southern Europe where investors dared not venture at the height of the debt crisis are now the focus of a rush into government bonds.

These countries, in various stages of slow resurrection from near disaster, have turned into a new El Dorado for investors seeking relatively secure but satisfactory returns.

This flow of money, much of it withdrawn from emerging markets, has pushed up the euro, and also pushed down borrowing rates for these countries, a critical factor enabling Portugal to emerge from its bailout corset on Saturday.

Until the beginning of July, 2012, much of the debt issued by Greece and Portugal, both in rescue programs, and of Spain and Italy considered to be in danger, was considered toxic by most investors, many of whom were barred by contracts with savers from holding such debt because it was rated as too risky.

ECB Turns the Tables

But in one breath, the new president of the European Central Bank Mario Draghi turned the tables, saying that subject to the progress with reforms being pursued, the bank was prepared if needed to buy vast amounts of eurozone debt.

This put a safety net beneath eurozone bonds and the euro, subject to tough conditions, and the announcement immediately reduced the risks of buying bonds issued by the stricken countries.

Already some speculative investment funds had bought into the debt of Ireland for example, the first country to emerge from a rescue program funded by the International Monetary Fund and European Union.

Since the beginning of this year the flow of investment into the rejuvenated bonds has accelerated rapidly.

Countries with debt problems were tipped into crisis when the rates the markets charged to lend to them rose above 6.0-7.0 percent.

Rates for Spain and Italy recently plunged to record low levels below 3.0 percent, although poor first quarter growth figures released on Thursday sent them back above that level.

Portugal's borrowing rate has fallen below 4.0 percent.

This is because government bonds carry a fixed rate of interest for the life of the loan they represent, in the form of an annual cash payment set when the instruments are issued.

If perceived risk rises, and investors shun the bonds, the price of the bond falls. This automatically raises the value of the fixed cash payment or yield as a percentage of the lower price.

This process has zoomed in the opposite direction this year, with yields falling, for reasons which analysts say are rational even though these countries still face deep problems, as evidenced by the retreat of Portugal and Italy into economic contraction in the first quarter of the year.

Within the eurozone, the government bond market plays the role which the foreign exchange market used to play before the euro was created: when a country is in trouble, its bonds fall, when it gets back on its feet, its bonds rise.

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