An update on the European poker game

Last month we wrote a blog entry about the ‘game’ that is playing out in Europe with respect to the Greek debt situation, the proposed EU/IMF bailout, and Germany’s reluctance to go along with the plan. A thorough discussion of the issue surrounding a potential default can be found in a Financial Post article. 

The Flop

A Reuters article confirms that Fitch has cut Greece’s credit rating, as expected. The rating is now B+ which puts it well into the “junk” category. Most investment policy statements of mutual funds and pension funds prohibit the holding of bonds rated less than BBB (or equivalent). The rapid selloff has lifted the yields on Greek bonds to 16.18% (Bloomberg June 25/11). With debt of 150% of GDP, this means that the interest payments alone take up 24% of GDP. An article in the online version of TIME magazine indicates that Germany has capitulated on their demand that Greece roll over maturity dates, and will join France is supporting the bailout. The bailout is contingent on Greece significantly reducing their deficit.

The Turn

The Greek coalition government has fallen apart over the austerity budget that is required to meet German/French conditions for the EU/IMF bailout. A reshuffling of the cabinet has been met with protests from other parties according to a CNN article. The general populace does not want to bear the brunt of an inefficient and corrupt government and has taken to the streets in protest. A Reuters article explains the alleged corruption and shows photos of the scale of the Greek protests. The bailout is contingent on the austerity measures that must be passed and implemented by a coalition government that can’t agree and imposed upon a population that refuses to accept those measures.

The River

So, as time runs out in Europe, we wait for the last card to be turned and find out who is bluffing. The betting is taking place in the market for credit default swaps where the rate on the 5 year CDS is 2025 basis points (20.25%) according to fxstreet.com, and on the foreign exchange market where the euro has fallen to a 3-week low, according to a Reuters article. We’re still betting on a bailout, followed by an orderly restructuring of Greek debt supported by the private institutions that hold the debt.