Beware the Greeks, though not just yet

Posted by Cardiff Garcia on Sep 03 15:37.
 
Here’s an interesting chart ripped from the CFR Geo-Graphics blog:

Notice anything strange?
The European Stabilization Mechanism was announced on May 11, the date represented by the blue bar in the middle of each time-to-maturity listed. For maturities of one and two years, the market’s expectation for a default (represented by Greek-German spreads) remains lower than before the ESM was announced. For a three-year maturity, it’s roughly the same as before.
But if you go any further along the timeline, the market is now pricing in more risk than before the ESM came into play.
Why has the market increased its confidence in Greek short-term debt but reduced it for the long-term?
Some of this might be explained by a simple preference for long-term bunds driven by other factors, but CFR offers a less sanguine explanation (emphasis ours):

Greece will happily borrow from the ESM to avoid having to close its primary deficit (that is, excluding interest payments) too rapidly. Yet if Greece is successful in eliminating its primary deficit, its temptation to default will actually grow, as it can wipe out huge amounts of accumulated debt without any longer needing the financial markets to fund current expenditures. If faced with the choice between paying Greek debts and letting Greece default, its northern neighbors may, once their banks are on more solid footing, find it more attractive simply to let Greece default. This is the story line that the markets are now pricing into government bond spreads.

Oh dear.

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