The markets expect a Greek default and time is running out. However, banks still haven't recognized enough of this loss, highlighting the pent-up risk in the sector. Deep-seated skepticism continues to drive market volatility and this will continue until a credible plan is on the table.
A Greek default due
Markets are pricing in a 93% probability Greece will default, with the country missing its deficit reduction targets, contracting greater than anticipated (-5.5% vs. -3.8%) and unable to meet salary and pension obligations within the next couple of weeks. However, there is still much uncertainty on what the next steps will be. Politicians are still clinging to the hope further bailouts will help and hinting they will demand private investors to bear a bigger part of the pain ("technical revisions" to allow greater haircut) but Finland is demanding collateral and time is running out.
"Time to move"
Despite 'kicking the can down the road' and delaying decisions over the next tranche of the Greek bailout, the markets are looking to the G20 meeting in Cannes on 3rd-4th November as the final deadline for decisive action. Political pressure is high as Geitner demands it's "time to move" and Obama issues some stark words accusing the EU of having a fiscal plan that is "scaring the world."
Banks are not prepared
Dexia, one of Europe's largest banks, hit the news with their need for some form of rescue. Their reliance on short term funding may be their current problem but the outlook is no more rosey. They have only reduced the value of their Greek bond debt exposure by 21%. If they, along with BNP Paribas and Soc Gen write-down these debts by 51%, that will cause massive losses amounting to €3bn. That's of course assuming Greece doesn't fully renege on all outstanding loans due.
Pent up risk
Therefore there are still many events that could shock the markets. Although so far market falls have been followed by short term rallies as investors use the opportunity to buy back into the markets. Crucially though, upside and downside moves are exhibiting a large amount of intra-day volatility. This highlights the deep-seated skepticism that will only be removed once a credible and clear long-term plan is put into action. Until that time, the swings will continue.
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