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The Greek financial markets are telling a story of huge stress and while the Greek ten-year bond rose a modest 65 basis points last night to 10.74%, the short-end is where all the fireworks are. The three-year Greek bond rose a massive 308 basis points or 3.08% and at 21.08% has risen dramatically from 9.41% since 23 January.
The inverted curve (i.e. short-term bond yields significantly above that of the longer-term maturities) tells a story of incredible pressure. The curve is complimented by an elevated read of Greece’s credit default swaps (CDS – which measure the cost to insure bonds against default). This suggests there is a strong probability of default over the next five years.
The Athens stock market also fell a further 4.75%, with banks at the heart of the selling once again.
Naturally, the Greek situation deserves more than a few paragraphs, but the crux of the matter is that since the 2012 bailout, Greek debt has continued to rise to 175% of GDP and the bottom line is this equation is unsustainable and there just isn’t any chance of a repayment. The European creditors know it, however they are still adamant that the new Greek government should recommit to the program of austerity, despite debt loads increasing. Importantly, Greece is now running a primary surplus, so it’s actually balancing its budget much more successfully.The Syriza party led by Alexis Tsipras, however, has promised voters fiscal easing (such as replacing the current property tax and re-instating the tax free threshold of EUR12,000), halting infrastructure privatisation and labour market reforms.
We already know that, as of tomorrow, Greek banks can no longer use Greek bonds as collateral to receive cheap loans from the European Central Bank and will now have to pay a much higher premium to get liquidity from the Greek central bank. On Thursday, Alexis Tsipras will meet other European leaders in what will be a very tense affair and these discussions take place some two weeks before 28 February and the date by which Greece was meant to accept the terms of the existing bailout program.
This is where things get tricky, as the Greek public are largely in favour of remaining in the Eurozone. H owever, the population has been promised more favourable living conditions by the Syriza government. A failure to live up to those pledgess will likely see their term in government come to an abrupt halt, or social unrest will make front page news.
On the other side of the coin, a ‘haircut’ or a write down of Greek debt holdings by EU institutions will not be accepted by key creditor nations such as Germany. But at the same time, the current Greek debt situation is unsustainable, so what is the likely outcome? Well, if we are to see a compromise it will likely come in the form of altering the composition of the debt structures. Here the current agreed maturities would need to be lengthened (this currently averages out to 18 years among the different creditors). The interest rate on the bailout would also need to come down (this is already a low 2.5%) and Greece would be allowed some degree of flexibility to control its fiscal position.
If the EU creditors concede here and Greece can find some middle ground then this could actually lower the net present value (NPV) of Greece’s debt burden by close to 20%. If no decision is reached then this opens up the idea of Greece leaving the European Monetary Union, something Alan Greenspan feels is inevitable.
The key issue is how Greece handle a total of €17 billion in maturing debt and loan repayments this year. Some of this is due in Q1 and Q2 and a failure to agree terms here will really throw up the idea of a Greek default and subsequent exit from the EMU. It’s how Greece can navigate itself through the repayment schedule that is so important.
What happens if Greece leaves the union is obviously not yet known, but it won’t be pretty. The fact that European equity markets are still near all-time or multi-year highs suggests the ECB’s recently announced quantitative easing program is helping support assets, and one suspects EUR/USD will be headed convincingly to parity on an exit. Other European bond markets like Spain will no doubt see higher bond yields as traders ask if a similar fate could happen there.
It seems realistic the market is under-pricing the prospect of a Greek exit. As we approach the set deadlines, we need to think about protecting portfolios or looking at trade structures which should move dramatically ahead of the mentioned deadlines. I feel short EUR/GBP on rallies to £0.7480 (the 38.2% retracement of the recent sell off from £0.7594) look compelling, with a stop loss at £0.7611 (just above the February high), potentially adding to the positon on a closing break of the 25 January low of £0.7405. The fact the pair has broken out of the multi-month channel suggests the trend is lower and if we do see additional tensions in Greece (which is likely) then the pair should fall.