The fate of Greek bondholders will be determined by Germany in the next two weeks as they are the line in the sand in how to proceed next. Greece announced more tax hikes and public official wage cuts over the weekend but they are past the point of no return with their current capital structure. Merkel in a German newspaper wants to give Greece time but both her allies and opposition seem to have had enough and want an orderly bankruptcy for them. Greek debt continues to point to the latter as the 1 yr yield is now at 111.7% and 5 yr CDS up to 3500 bps. Fears of sharp mark downs and the expiration of Moody’s 3 month review period of them has French banks down sharply as a credit downgrade seems inevitable. Make no mistake though that the French will do all it can to plug any capital holes that their banks have. We know Germany is preparing for the same and we have to believe that every other European country is doing the same. Stress continues to increase in European interbank lending markets as measured by the euro basis swap and euribor/OIS spread. Italy’s lower house will vote on Wed on their new budget plan and it’s expected to pass. Italy sold 1 yr notes at a yield of 4.15%, 119 bps above one sold in Aug. Italian 5 yr CDS is now above 500 bps for the 1st time. Bottom line, pain is inevitable for Greece, its bondholders and European banks no matter what the outcome is for them but coming out on the other end of this situation with much lower debt levels, aka a default, would at least lay the foundation for economic recovery
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