• Over the past couple of days the spread widening between Greek government bonds and German Bunds has been massive. The shorter end of the GGB curve has been harder hit than the longer end.
  • The Greek stability plan sees the budget deficit cut from an estimated 12.7% of GDP in 2009 to 2.8% of GDP in 2012. This is an immense task.
  • Compared with other countries, the Greek stability programme is very dependent on revenue increases. We would like to see more expenditure cuts.
  • It is key that the Greek government quickly begins to show more than good intentions. As Mr. Weber has warned “Actions speak louder than words”.
  • We think that a Greek default is not an option for the EMU. It is likely to be highly contagious and would undermine the whole project.
  •  If confidence does not return, the most likely solution would be a heavily conditioned loan granted by some or all of the euro-group countries. This would effectively put Greece under some kind of administration.
  • If Greece chooses to default, it will be unable to get financing and would need to have a balanced budget after all. This would probably be even more painful than undertaking the tightening needed to satisfy the market.
  • We find it inconceivable to have an EMU member whose government bonds would not be eligible as ECB collateral. It seems possible that the ECB could keep Greece on its list of eligible marketable assets without changing the collateral framework.

Recent market developments

The spread widening we have witnessed over the past couple of trading days is massive. The 2Y GGB-Bund spread has widened from around +160bp to currently over 300bp over the past two weeks of trading. Interbank liquidity has been poor, bid/offer spreads have been very wide, and it has been difficult to trade as the yield movements intra-day have been tremendous on GGBs. The shorter end of the GGB curve has been harder hit than the longer end. This is probably because of market positioning as brokers/fast money have been long the short end whereas real-money investors have typically been in the longer end. As the speculative positions have been stopped out, we have seen a large flattening in the GGB curve. Hence, the 2Y GGB-Bund spread is currently wider than the 10Y spread as illustrated in the chart to the right. Further rating downgrades of GGBs could result in a vicious cycle where more credit departments close down trading lines on GGBs. Greek banks own a notable share of GGBs, but nevertheless it is estimated that as much as two-thirds of GGBs are owned by foreign holders.