Monday, 26 April 2010

Betting on the Euro

Another day another crisis for the Euro. Greek sovereign debt has now ballooned out to a 13% yield to maturity. Quite phenom anal, when you think back to the inception of the Euro and all sovereign risk premia were rapidly priced out of the market.

The dispersion on sovereign spreads is now quite dramatic. Ireland's are back to 2% (a country not massively dissimilar in fiscal characteristics to Greece). One way to interpret these developments is as a price on Euro break up.

If Greece never leaves the Euro, any holders of Greek debt will suffer Euro inflation risk only. With a 13% nominal annual return to maturity, I reckon that is a bet well worth having.

Secondly, if Greece never leaves the Euro it is difficult to see a debt default occurring. The most likely scenario in which the more fiscally sound members of the Eurozone allowed Greece to default would be one where fiscal problems were so widespread and large (say to Spain, Ireland and Italy) that a bailout of Greece would require an unaffordable bailout for all. And should that happen, it is surely almost certain that the Euro would break up, leaving Greece on the outside.

Considering those factors combined and if you agree with the logic, what you have here is a bet that Greece will still be a member of the Eurozone in 10 years time. Markets would appear to think this is increasingly likely that Greece could bring down the Euro.

So do you feel lucky, Punk?

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