naked capitalism

Given how many commentators believe that Greece is destined to default on its bonds (particularly since they are subordinate to any new money from the IMF and EU), you’d think they’d be putting their money where their mouth is.

But the old saw in the US is “don’t fight the Fed”. And the same logic appears to apply with the ECB. John Dizard of the Financial Times reports that perilous little in the way of CDS contracts is being written on everyone’s favorite sovereign default candidate (although the leader of Fine Gael, which will be leading the new coalition in Ireland, fired a shot of sorts across the bow of the eurozone officialdom). From Dizard’s article:

The truth is that the outstanding net CDS volume on, for example, Greek sovereign risk is less than 2 per cent of the outstanding state debt. That’s less than $6bn on about $490bn, for the dollar denominated contracts. There is more liquidity in the dollar contracts, which, given the location of many hedge funds and relative lack of official hostility to the instrument, makes sense. Even so, the derivatives tail, far from wagging the dog, is really vestigial.

The hedge funds and remaining prop trading desks are well aware of euro area official hostility to derivatives that provide a way to bet against policy. So if there are bets to be made, there won’t be many through the CDS market.

Even in the market for actual bonds, there is a reluctance to put on short positions that could be subject to official squeezes on the freedom or cost of borrowing securities. Also, with an announcement of some proposed debt crisis solution coming around the time of the March euro area summit, there could well be another short term pop in the price of peripheral market debt. Why take the risk?

Despite the lack of aggressive short selling, or buying of protection through CDS, the price of peripheral country bonds drifts lower, as real-money end buyers continue to try to be real-money end sellers. They have not, however, drifted anything close to low enough to make possible any meaningful debt relief through official buybacks. For that you can thank the ECB’s repo facilities and purchases, which have artificially kept up the price of Greek law-governed paper.

Note that this does not mean traders won’t find a way to play periphery country tsuris. It just is not likely to have sovereign debt as its centerpiece. Given that the sovereign debt crisis is deeply entwined with the efforts to prop up the banking sector, you can guess one of the first places they might look for interesting wagers.