As a potential Greek default looms once again, we take a look at 4 charts to see: 1, how likely is a Greek default in the short term; 2, could this affect other Eurozone countries? 3, what will be the fall-out for markets.
Chart 1: The bond market believes a default is likely
The three-year Greek yield is most sensitive to the latest fears that Greece won’t be able to pay back its debts. As you can see, this yield has surged to nearly 28% on Thursday, its highest level since 2012. Yields have been rising along the curve, with Greece 2-Year and 10-year yields also increasing in recent days, however, the 3-year is under the most pressure as it corresponds with the maturity of Greek bailout funds.
To put this in context, back in 2012 the 3-year yield surged above 120%, so this yield could have further to go if negotiations between Athens and its creditors continue to deteriorate in the coming days.
Figure 1:
Source: FOREX.com
Chart 2: Although the cost to insure Greek debt from default has risen, it is still well below the levels reached in 2012.
The cost to insure Greek debt from default has also surged, although it remains below the levels reached earlier this month. At 2,377 basis points, this is the highest level it has reached since 2013. As with the 3-year bond yield, however, this is still significantly lower than it was in 2012, when the cost to insure Greek debt from default surged to nearly 26,000 basis points.
A couple of reasons why CDS spreads have not surged back to these levels include: 1, there are less investors who hold Greek debt as it has been receiving bailout funds in recent years. 2, Some of those investors who do own Greek debt may not want to purchase default insurance, presuming instead that European authorities would pave the way for a “managed default” for Greece, where creditors would receive their money back.
Figure 2:
Source: Bloomberg and FOREX.com
Chart 3: This time around there is no contagion from the Greek crisis to other peripheral Eurozone members.
This is one reason why financial markets are seemingly so calm about the prospect of a Greek default; it is unlikely to lead to a domino effect in other Eurozone markets. The chart below shows Greek and Portuguese yields of a similar maturity. As you can see, 2-year Portuguese yields barely yield anything, suggesting that the market is not tarring Lisbon with the same brush as Athens.
Figure 3:
Chart 4: Could a Greek default make the German stock index, the Dax, more attractive?
We think yes. As Greece seems to be getting closer to the financial abyss, German bonds are attracting safe haven flows. Since bond prices and bond yields move inversely to each other, as demand for German bonds rise, it pushes down German yields. The 10-year yield is nearing zero per cent. Although not the first to have a 10-year yield below zero, the Swiss yield fell below 0% earlier this month, it is significant for Germany in this low yield environment and may continue to push investors into riskier assets in the coming weeks.
We think that European stocks, including the DAX index, could be the beneficiary. Although this index has reached a record high, it may outperform its US counterparts for a few reasons including:
- Stocks can become more attractive in a low yield environment.
- German stocks may benefit from the ECB’s QE programme, which is set to continue into next year.
- US stocks, while still appreciating, could come under pressure later this year if the Fed decides to hike interest rates.
Figure 4:
Source: FOREX.com
Conclusions:
From these four charts we can come to a few conclusions about what a Greek default could mean for the markets:
- The focus of a potential Greek default is mostly being felt in the Greek bond market.
- Greek bond yields and Greek credit default swaps are some way away from the highs reached in 2012, suggesting that the markets are more sanguine about the prospect of a default in 2015, compared to 2012.
- The risk of contagion to other Eurozone economies is also very low.
- A Greek default could make German stocks more attractive. As investors sell Greek debt they are buying German debt, and the 10-year yield is approaching 0%. In a low yield environment, this could make German stocks even more attractive, after they recently reached record highs.
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