The Greek default trade

Jun 14, 2011

The Greek time bomb hasn’t been defused by any means, but for now it isn’t ticking quite as loudly.

In the glass half full of something nasty department, the price of insuring Greek bonds for a year has come down lately (see chart, right), according to data provider Markit.

This suggests not that the situation in Greece is improving, mind you. The country is still buckling under a recession that’s being deepened by harsh austerity plans, while its debt load continues to rise.

But Markit analyst Otis Casey ventures that the recent pullback in short-term CDS prices suggests traders are wagering that European officials will find a way to ease Greece’s acute cash crunch without triggering default provisions on the credit default swaps quoted in the above graph.

A voluntary restructuring that didn’t trigger CDS payouts would be good news for those who have been raking in big bucks writing swaps on Greek debt – including, some observers suspect, our friends at the taxpayer-backed U.S. banks.

At the same time, the record prices of five-year Greek CDS show that market players believe the odds of an eventual default are rising. That is a conclusion reached this month as well by S&P, whose latest downgrade Monday left Greece’s rating two notches above default, and Moody’s, which last week assessed the default odds at 50-50.

The latest market assessment, if you're keeping score at home, puts a 74% chance on a Greek default by 2016. Clearly, Casey writes, “investors believe that the probability of a default or restructuring that will ultimately trigger CDS is high.”

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