Greece may not default – but still be insolvent - CNBC Comment

It’s now looking worse for the Hellenic Republic than ever before

How important is Greece to Europe? The real answer is that nobody really knows. But time doesn’t stand still, and we are now moving closer to some very real debt repayment deadlines.

Athanasios Orphanides, former member of the European Central Bank (ECB) Governing Council, told me last week that he thinks the ECB is in an impossible position. While it’s popular (and partly justifiable) to blame the Greek government, he argues, the main reason for the failure of the Greek program has to be traced back to May 2010. The German government forced an “unworkable” program on Greece to protect banks from losses. Greece has been caught in a debt trap since then, he says, and it’s now looking worse for the Hellenic Republic than ever before.
We are currently seeing an inverted yield curve for Greek bonds, indicating that investors think there is a high risk of default. Alberto Gallo, head of European macro credit research at RBS, told me he thinks a Grexit is unlikely – but that the chance of a Grexident is rising. “Greece could very well have a cash shortfall: it can either choose to pay the IMF, or it can choose to pay public pensions and payrolls. But it can’t pay them both. We could soon have a period where Greece is not in default… but where it isn’t solvent either.”
Gallo says that, while European high yield has been the best performing asset across Europe, RBS recently took off some of its position. He doesn’t think Greece will lead to a systemic crisis, and Gallo reminds us that 80 per cent of Greeks still want to stay in the euro.

US BOND TRADE BUILDING

As European debt continues to see yields pushed to record lows, both as a consequence of the ECB’s bond buying programme and, in the case of Germany, a flight to perceived safety, Peter Rosenstreich, chief foreign exchange analyst at Swissquote, pointed out to me that we could see a flight to quality away from European debt into US debt. He highlights the widening spread between US and German government bonds, and says: “The trade is just building itself. Why hold German debt when you can get 180-190 basis points in the US?” Orphanides doesn’t think the trend of negative bond yields will continue on the longer dated paper. He argues that, depending on ECB action, we could expect spreads between Germany and other countries to be reduced.
Rosenstreich still has a euro-dollar target of parity within six months. He thinks we could experience more positive economic data this summer, entrenching expectations of a September Fed rate hike.

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