The curve below indicates that bond investors now believe that Greece will likely default in under 6 months, or at least the EMU will realize that Greece is a lost cause and cut it off, despite all rhetoric to the opposite. Actually, with the 3 month trading at a mindblowing 4%+, which we are fairly confident is a record for any country, let alone a EU and EMU member, one can claim that the country will not see July in its current political form. The 3M-6M spread of nearly 300 bps is an all time record for a developed country. Past the 6M point, you can see all the way to the Pacific. Note the curve shift from April 2009, when the 3M was trading at just over 1%. At this point the only question is whether the 3 Month will join the other points on the curve in the 7% ballpark.
We believe the sequence of next steps is now as follows:
1) Failed auction for Greece
2) Euro drops to sub $1.30
3) EU effectively isolates Greece and takes it out of the EMU in practice if not in theory
4) Euro tumbles to $1.15
5) Bernanke realizes the implications of a surging dollar for the US trade balance, and reinstates QE, cranks up the printing presses, sending the dollar plunging and the euro surging back to the $1.40 level