It comes from Harvinder Sian of RBS:
Net/net, our base case that the default of Greece will centre around the Dec-11 review is still plausible and our arguments on why it can not come around the Sep-11 review are only tactical. In any case, a Greek default is coming and is a pivotal factor is our assessment that all EGBs ex-Germany at this stage are still speculative investments.
It’s to the point…
The case is a bread-and-butter one of Greece missing targets and the EU or the IMF pulling the plug. An Argentine case really. Even the months are in order. On the other hand it’s extremely difficult even now to determine the likelihood of pulling the plug, there are other moving parts (Greek banks, Greece’s current bond swap…)
This point is also interesting:
Are GGBs already priced for default? That is not the same as trying to figure out the recovery rate. In event of default expect prices to move to a 20-handle as markets could be stuck in limbo for some time and markets will fear that a Greek EMU exit is the next phase. Assuming that Greece remains in the Euro, prices can then recover towards 40-50c, though here we are assuming that debt/GDP will peak in the region of 160% and not much higher otherwise recovery will be lower…
Now, we know that expectations of relatively high recoveries have been among the reasons for recent punts into Greek bonds. There are others, for example acquiring specific bonds that are eligible for the debt swap but trade cheaper than the swap’s terms imply.
Anyway — recent one-year Greece CDS (chart via Markit):
Obviously, illiquid as this end of the Greek CDS curve is, it’s been affected by the kind of concerns over a short-term “hard” default that RBS notes above. Actual composite recoveries quoted within Greek CDS contracts remain at around 38 (i.e. recovery of 38 cents in the euro from a bond tendered as part of a credit event) according to Markit. Pricing on (say) a Greek recovery lock would provide a fascinating insight but this isn’t easy to come by sadly (nor are these instruments likely to be traded very much). A 38 recovery isn’t far off levels of a few months ago even so.
But as was pointed out to us yesterday, pricing one-year CDS at levels close to 5,000bps (or even two-year CDS at 2,500bps) suggests someone is prepared to accept a heavy premium to get repaid in full via credit protection, indicating some kind of recovery tail risk from a short-term default. You can think of all kinds of ways in which that tail risk might well manifest (Sian notes the vulnerability of Greek law bonds to a vote by the Greek parliament to restrict terms for instance) but clearly it’s as present as ever.
On the other side of the trade — RBS do note that their long-term prediction for ten-year bunds to trade under 2 per cent has come true at last…
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