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Beyond Greece: The Three Scenarios

Submitted by Tyler Durden on 02/20/2012 10:09 -0400

As forecasts for peripheral macro data continue to deteriorate and core to strengthen modestly, there is little real comfort available from the European situation aside from the 800lb gorilla that all headlines are focused on today. Credit Suisse describes it as "a case of the outlook being less bad than expected, rather that it being better" and notes that post the Greek situation, despite the ongoing rally in the ever-thinning sovereign bond market, that risk premia (that were dangerously forgotten for the first decade of the Euro) will remain at elevated levels. CS sees three scenarios beyond Greece with even the best-case leaving questions of sustainability, trust, and continued negotiations yet the market's willingness to follow along the path of inevitably ruinous policies seems writ large with today's credit, equity, and FX strength.

Economic growth forecasts revision - core up and periphery down

Looking beyond Greece we think the key factor driving spreads and yields will be the growth prospects of European countries. In the pre-crisis days low growth implied low yields. This may continue to be the case for core markets, but for non-core markets a lack of growth means that the debt burden, and hence the risk premium, will remain high. In pre euro days we see a positive correlation between yield levels and growth. This is less evident post euro and the most recent development is that yields have been rising as the growth outlook has been declining.

We think this marks a significant change in market perception of sovereign risk. For the first ten years of the euro the market has effectively priced out the risk premium for European sovereigns. On the basis that Greece is resolved in a relatively orderly fashion, we think markets will continue to price in this risk premium, and although peripheral spreads may experience some tightening versus core, we think the risk premium remains at elevated levels.

(Trying to) look beyond Greece

As we monitor developments, and look to evaluate the outlook for the European government debt markets post the 20 March, we therefore see broadly three general scenarios:

Debt restructuring completed in (relatively) orderly manner and vast maturity of Greek debt has been restructured, second bailout in place.
Partial restructuring with ongoing debate – continuation of current situation.
Failure-to-pay or debt moratorium on 20 March bond.

As we proceed towards a solution, we expect the market to remain volatile and the periphery to sell off; the longer we go without a clear proposal and timetable for implementation, the greater the probability of an “accident” and therefore the greater the likely risk-off moves.

Once the details have been released, if the debt exchange appears to be proceeding as intended, with a high probability of the first scenario being achieved, then we believe the periphery will outperform and bunds will sell off; near-term volatility could provide a good entry point for these positions.

Despite a deep debt restructuring, Greece would be likely to continue to provide headlines – the severity of the austerity measures and the dire state of its economy mean it will need support from the euro area for the long term in order to regain competitiveness, and this route is unlikely to be smooth or popular with electorates inside and outside Greece. Once the vast majority of private debt has been restructured and termed out, it is possible that the situation in Greece has little ongoing impact on the broader markets, with sentiment driven by developments at the other sovereigns, and likely in the banking sector. This, we believe, is a plausible scenario for post-restructuring Europe provided that the political situation in Greece remains relatively stable and the long-term commitment of the euro area to Greece is in no doubt. A continuation, or escalation, of the discussion of Greece being better off outside the euro area would be extremely negative in our opinion, leading to further volatility and contagion and is a substantial risk.

Scenario two is more of the same as we’ve had recently, with the associated negative implications for market sentiment. The periphery would likely sell off further, with the potential of increased contagion towards the core, as there would likely be increased scepticism of the ability of policymakers to reach an agreement and increased talk of Greece leaving the euro.

Scenario three as we have said above would be catastrophic, in our view – Greece would almost certainly need to leave the euro, and contagion would continue into the core of Europe in time. In the absence of substantial additional policy intervention, we would expect an immediate and substantial widening in peripheral spreads. The initial move in German yields would likely be a rally, but we don’t believe this would be sustainable, as the risk premium required in German bonds would need to increase significantly. The time frame for moves would be a function of other measures put in place in order to stem the contagion.

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Mon, 02/20/2012 - 10:11 | 2177266 maxmad

I only see one option:

DEFAULT!

Mon, 02/20/2012 - 10:14 | 2177273 GeneMarchbanks

Notice how that word isn't used in the article?

Mon, 02/20/2012 - 12:05 | 2177601 LowProfile

That would be "Scenario Three". Greece returns to the drachma, and defaults via devaluation.

...Comin' right up!

Mon, 02/20/2012 - 10:51 | 2177368 duo

Options:

1 Default

2. Austerity. Greece becomes a European Somalia with starvation and disease. Emergency aid in the billions and a refugee crisis.

3. Revolution. The government flees the country and a dictator replaces the technocrats. Drachma returns and default happens anyway.

A collapsed Greece living off of aid from Europe may be more expensive than default right away.

Mon, 02/20/2012 - 13:01 | 2177810 chipshot

..almost shaped like a Pentagram...

Mon, 02/20/2012 - 10:15 | 2177272 JohnnyBriefcase

"I only see one option:

DEFAULT!"

It's the only real option so they will fight it to the death (of us all).

Mon, 02/20/2012 - 10:15 | 2177276 Quintus

So, things will either (1) get better, (2) stay the same, or (3) get worse.

Got it. Thanks for that, Credit Suisse. I sure wish I had a research team capable of distilling complex issues down with such clarity.

Mon, 02/20/2012 - 10:16 | 2177280 JohnnyBriefcase

Well, nothing ever really gets better and nothing ever stays the same so where does that leave us?

Oooh something shiny!

What did you say?

Mon, 02/20/2012 - 10:20 | 2177289 GeneMarchbanks

Don't be an asshole, they have a chart with uh... like a spider-web and... er...

Mon, 02/20/2012 - 10:28 | 2177310 mayhem_korner

I think they live just to publish the charts. Can't you see the other bankster-researchers scrambling: "we need to do a chart like that."

Mon, 02/20/2012 - 11:31 | 2177476 LarryDavis

These assholes are making 200k to write this drivel. Wall st. memos/research is possibly the most bizarre, sadistic, masturbatory fetish out right now. These monkeys are on instant messenger all day.

Mon, 02/20/2012 - 13:27 | 2177887 Matt

Not anymore; the article was likely generated using Narrative Science, using the writing style and analytical analyses of someone who USED TO get paid $200 K per year, but is now unemployed.

Mon, 02/20/2012 - 14:21 | 2178042 Jacks Nipple

NO, a computer wrote that...

EDIT: oh, somebody beat me to it.

Mon, 02/20/2012 - 10:30 | 2177309 falak pema

Beyond Greece : there is oily grease from strategic Turkey. As that fellow traveller would say : boring world we live in. My turkey is fine in this sauce :

Turkey Gravy Recipe That's Easy and Delicious

Mon, 02/20/2012 - 10:28 | 2177311 crash_davis

its the spider web of doom. pick a scenario to determine the level of doom.

Mon, 02/20/2012 - 10:28 | 2177312 mayhem_korner

The purpose of a forecast is to provide a precise measure of just how wrong we were. (Anonymous)

Mon, 02/20/2012 - 10:29 | 2177314 eddiebe

There is only one way to stop the banksters. Disclosure: Long rope and lampposts.

Mon, 02/20/2012 - 11:50 | 2177549 Byte Me

Pass that on to any protesters would you?

THEN, instead of burning stores / shops we might see some 'productive behaviour'

Mon, 02/20/2012 - 10:30 | 2177318 Dr. Engali

Wow that's three minutes of my life I won't get back. What a terrible piece. And what is the spider web about? Besides oh what a tangled web we weave...

Mon, 02/20/2012 - 10:31 | 2177321 tom a taxpayer

Which of the 3 scenarios includes the potential downgrade of Credit Suisse by three levels, or is it in all 3 scenarios.

http://articles.economictimes.indiatimes.com/2012-02-17/news/31071387_1_...

Mon, 02/20/2012 - 10:42 | 2177325 Mercury

Doesn't really address ZH's (and others') argument (aka the elephant in the room) that the ECB's Greek debt swap/private holder cramdown will kill future bids for (especially peripheral) Euro Zone sovereign debt.

Mon, 02/20/2012 - 10:48 | 2177362 slewie the pi-rat

that chart is h-o-t!

it puts the lead in slewie's pencil, BiCheZ!

Mon, 02/20/2012 - 11:10 | 2177418 machineh

It's inspired by Kindleberger's famous 'spider web chart' showing global trade gurgling down the drain between 1929 and 1933.

Kindleberger's original chart is reproduced in a Kurgman article here:

http://krugman.blogs.nytimes.com/2010/07/10/hayek-trade-restrictions-and-the-great-depression/

Mon, 02/20/2012 - 11:10 | 2177417 iamtheeggman wh...

oh nose- the swirling drain chart!

Mon, 02/20/2012 - 11:13 | 2177424 iamtheeggman wh...

Many thanks (again) for the superb reporting on all things Euro. ZH deserves to be recognized for it.

Mon, 02/20/2012 - 12:56 | 2177788 Olympia

World War III - The First Private Was in History

Those who won all battles shall lose the war. Bilderberg Group and the crimes against humanity.

In 1991, when George Bush senior attacked Iraq and tried to establish the New World Order, has actually provoked a World War. A war the human kind has never seen before; a world war that may not have had the provocative blood-letting of the previous wars, nevertheless its consequences were equally bad for all the peoples. A financial world war, the consequences of which may not have been dead or amputated men and ruins, but in any case they were equally disastrous for both the peoples and the environment.

http://eamb-ydrohoos.blogspot.com/2012/02/world-war-iii.html

Authored by PANAGIOTIS TRAIANOU

Mon, 02/20/2012 - 13:58 | 2177988 witm99

Found this Greek default adventure game http://crookedtimber.org/2012/02/16/so-what-would-your-plan-for-greece-be/ and had to implement it in Javascript.

http://jsbin.com/abidah

http://pastebin.com/e9FSn8We

Mon, 02/20/2012 - 14:26 | 2178055 Jacks Nipple

I will be in greece in july. To see the ruins of the old world, Acropolis, et al. and possibly the ruins of the new-old world. if there's not a ferry strike that is.

Will let you know first hand how sticky the spider web is.

Mon, 02/20/2012 - 14:48 | 2178109 bbelux

I don't get the point.

China is artificially controlling it's currency, Japan is printing the FED is printing, and the world is focusing on Greece. Ok this point a big failure in the EMU construction. But guys this not an Hedge Fund, this not an easy deleveraging process. This is a complicated balance to find between back on track regarding spending control, deleveraging and growth boost. I admit the equation can be tricky and you cannot maximize the function at the same time. But you have to do something.

Look at the achievement that have been made, i agree under the market pressure, but this is good pressure.

I think we will post for years on that crisis, but who is looking for a quick fix here?

The real part actually is : if I followed all the EUR bears; SOV BEARS, Equity bears and Gold LONG here, I would have made an horrible YTD performance. I don't says that i will change my mind anytime soon, but for the moment, and for the moment only, beeing selective in EUR equities and Bonds lead me to a nice YTD figure. And I hope this will last whatever the market does.

Good luck for your trades.

Mon, 02/20/2012 - 15:53 | 2178318 Archon7