A Brief Update on Yields, CDS Spreads and Implied Default Probabilities

Currently there are a number of weak spots in the global financial edifice, in addition to the perennial problem children Argentina and Venezuela (we will take a closer look at these two next week in a separate post).

There is on the one hand Greece, where an election victory of Syriza seems highly likely. We recently reported on the “Mexican standoff” between the EU and Alexis Tsipras. We want to point readers to some additional background information presented in an article assessing the political risk posed by Syriza that has recently appeared at the Brookings Institute. The article was written by Theodore Pelagidis, an observer who is close to the action in Greece.

As Mr. Pelagidis notes, one should not make the mistake of underestimating the probability that Syriza will end up opting for default and a unilateral exit from the euro zone – since Mr. Tsipras may well prefer that option over political suicide.

Note by the way that the ECB has just begun to put pressure on Greek politicians by warning it will cut off funding to Greek banks unless the final bailout review in February is successfully concluded (i.e., to the troika’s satisfaction). The stakes for Greece are obviously quite high. There are two ways of looking at this: either the ECB provides an excuse for Syriza, which can now claim that it is essentially blackmailed into agreeing to the bailout conditions “for the time being”, or Mr. Tsipras and his colleagues may be enraged by what they will likely see as a blatant attempt at usurping what is left of Greek sovereignty, and by implication, their power.

 

32a94b4f860c9ea010c2508169f36f36_XL

Image via Arabia Monitor

 

We have already discussed Russia’s situation in some detail in recent weeks (see for instance “Will There Be Forced Official Sellers of Gold”). As regards Ukraine, its economy is already doing what observers are merely expecting to happen with Russia’s economy in light of the recent decline in crude oil prices. In other words, It is no exaggeration to state that Ukraine’s economy is in total free-fall. The country’s foreign exchange reserves have declined precipitously, most of the central bank’s gold has been mysteriously “vaporized”, and what is left of it has turned out to be painted lead (no kidding, the central bank’s vault in Odessa was found to contain painted lead bars instead of gold bars – the thieves didn’t even bother with using tungsten).

Last year Ukraine’s GDP contracted by an official 7% and this year another contraction of 6% is expected. Ukraine’s government will need an additional 15 billion dollars to remain afloat, but there is currently no-one who wants to provide the money. The EU is itself short on funds, and JC Juncker let it be known that:

 

There is only a small margin of flexibility for additional financing next year. And if we fully use our margin for Ukraine, we will have nothing to address other needs that may arise over the next two years.”

Somewhat earlier, the authorities in Kiev asked Brussels for a third program of macro-financial aid in the amount of €2 billion. European commissioner for neighborhood and enlargement policies, Johannes Hahn, said the EU was prepared to continue aid to Kiev but only in exchange for concrete results of reforms. Finland’s Prime Minister Alexander Stubb said the EU would not take any decisions on extra financial aid to Ukraine right now because the country had not implemented the essential structural reforms yet.

 

(emphasis added)

We have little doubt that Ukraine’s technocratic prime minister Yatsenyuk is committed to implementing the reform demands, mainly because he has no other choice. However, in spite of Ukraine’s new government taking a few noteworthy steps to limit corruption (e.g. by appointing foreigners to head several important economic policy related ministries), the rotted edifice of the state’s administrative structures cannot be repaired overnight.

As a friend recently remarked to us, if one asks Ukrainians about this topic, most will report that the degree of corruption in the country is simply utterly beyond the imagination of Western observers. We would also guess that for many Ukrainian officials and civil servants, it has simply become a question of survival (i.e., many are forced to somehow improve their meager incomes). Anyway, for more than two decades, corruption has been a way of life in Ukraine for all strata of the administration from the very top down. This likely explains why economic growth in Ukraine has never recovered beyond the levels attained immediately after the dissolution of the Soviet Union. It has the by far worst economic growth record of the post-Soviet states.

To be sure, Russia is a den of corruption as well – but contrary to Ukraine, the rule of the oligarch mafia was seriously disrupted when Vladimir Putin took over. Although the oligarchs of yore were then replaced with new ones, their political influence has been vastly diminished compared to the Yeltsin era. Nothing comparable has ever happened in Ukraine.

Below is a chart showing current 5 year CDS spreads on Greece, Russia and Ukraine in a three in one package. Note that the scales are different for each (they are color coded). Ukraine’s CDS spread is at about 2028 basis points, which is the third worst reading in the world at present, below the cost of insuring against a default of Venezuela and Argentina. Greece comes next with a CDS spread of 1407 basis points. Russia with 547 basis points looks positively creditworthy by comparison (in fact, Russia’s total public debt only amounts to approx. 15% of GDP; it is one of the least indebted governments in the world). Nevertheless, the situation has obviously worsened quite a bit for Russia as well.

 

1-CDS Russia, Ukraine and Greece5 year CDS spreads on Russia (white line), Ukraine (green line) and Greece (red line). Keep in mind that the scales are different. Ukrainian CDS spreads are very volatile – they just declined by 338 basis points overnight – click to enlarge.

 

From these CDS spreads one can calculate the implied annual probability of default under different recovery assumptions (i.e., the percentage creditors can expect to recover after a default has occurred). The lower the recovery assumption, the lower the implied default probability. The most widely used recovery assumption is 40%, which we have employed in the charts below as well. Unfortunately the handy calculator we have found for this purpose for some reason doesn’t include Greece (possibly because after the PSI haircut, CDS on Greek debt ceased to trade for a while). However, one can make a rough estimate based on the implied default probabilities for other countries.

 

2-default probabilities

The implied annual default probability for Russia under a 40% recovery assumption stands at 7.6%, for Ukraine it stands at 17.1%.

 

We were unable to find a chart of Ukrainian bond yields that makes sense to us; there once existed a 10 year dollar-denominated bond, but Bloomberg’s chart of this bond yield is ends in mid 2013, and is therefore no longer relevant (possibly the bond was redeemed). Russian and Greek 10 year yields look as follows:

 

3-Russia 10-Year Bond Yield(Daily)Russia’s 10 year government bonds now yield a little over 14%. The three year bond yield stands at 15.9%, so the yield curve is currently inverted (as a result of Russia’s central bank hiking short term rates to 17.5%).

 

4-Greece 10-Year Bond Yield(Daily)Greek 10 year government bond yields currently stand at 10.25%. Three year yields however stand at 13.5%, so the yield curve remains inverted as well.

 

It is a bit of a mystery to us why Russian CDS spreads are so much lower than Greek ones, while Russian bond yields are significantly higher. Normally we would assume that embedded foreign exchange related expectations are playing a role in this, but since a Greek default would almost certainly entail a return to the drachma, this shouldn’t make that much of a difference. It seems therefore possible that some of these instruments are in fact mispriced. Of course, one needs to keep in mind that Greece’s government is de facto bankrupt and would have to declare insolvency if its bailout were revoked, while Russia’s government is far from insolvent and actually quite unlikely to become so.

Finally, here are long term charts of the ruble and the Ukrainian hryvnia. Both currencies are quite weak, but the hryvnia’s plunge has been noticeably bigger and more persistent since 2008 than the ruble’s, as the latter initially recovered from its 2008 crisis losses.

 

5-Ruble, weeklyUSDRUB, weekly – click to enlarge.

 

6-Ukrainian Hryvnia, weeklyUSDUAH, weekly – click to enlarge.

 

Conclusion:

Russia seems the least likely of these countries to actually suffer payment difficulties, but much will depend on future developments in energy prices and the ruble. Greece and Ukraine are both dependent on foreign public sector lenders and their willingness to throw more good taxpayer money after bad. Neither country can expect these foreign lenders to be overly patient or willing to countenance deviations from their conditions. Given the political and economic realities in Ukraine and Greece, outright defaults can therefore not be ruled out. One needs to keep a close eye on developments in CDS spreads and bond yields over coming weeks and months, as in both cases a further deterioration of the situation would have ramifications that go well beyond the countries directly concerned. In the short term, this may be more pertinent to Greece due to its connection with the EU and the euro area, but a more pronounced economic implosion and further destabilization of Ukraine would likely also harbor more wide-ranging dangers. The happy bubble in risk assets could presumably be derailed a bit if any of the possible worst case scenarios were to become manifest.

 

Charts by: Bloomberg, Investing.com, BigCharts

 

 
 

Emigrate While You Can... Learn More

 
 

 

Dear Readers! We are happy to report that we have reached our turn-of-the-year funding goal and want to extend a special thank you to all of you who have chipped in. We are very grateful for your support! As a general remark, according to usually well informed circles, exercising the donation button in between funding drives is definitely legal and highly appreciated as well.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to “Russia, Ukraine and Greece – Default Probabilities”

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • tintedFree Money Leaves Everyone Poorer
      Destroying Lives BALTIMORE – A dear reader reminded us of the comment, supposedly made by Groucho Marx: “A free lunch? You can’t afford a free lunch.”   Groucho dispensing valuable advice Photo via imdb.com   He was responding to last week’s Diary about the national referendum in Switzerland on Saturday. Voters will decide whether to give all Swiss residents a free lunch – a guaranteed annual income of about $30,000 a year [ed note: the initiative was...
  • offendFree Speech Under Attack
      Offending People Left and Right Bill Bonner, whose Diaries we republish here, is well-known for being an equal opportunity offender  - meaning that political affiliation, gender, age, or any other defining characteristics won't save worthy targets from getting offended. As far as we are concerned, we generally try not to be unnecessarily rude to people, but occasionally giving offense is not exactly beneath us either.   The motto of the equal opportunity...
  • French labour union workers and students attend a demonstration against the French labour law proposal in Marseille, France, as part of a nationwide labor reform protests and strikes, March 31, 2016. REUTERS/Jean-Paul Pelissier/File PhotoHow the Welfare State Dies
      Hollande Threatens to Ban Protests Brexit has diverted attention from another little drama playing out in Europe. As of the time of writing, if you Google “Hollande threatens to ban protests” or variations thereof, you will find Russian, South African and even Iranian press reports on the topic. Otherwise, it's basically crickets (sole exception: Politico).  Gee, we wonder why?   They don't like him anymore: 120.000 protesters recently turned Paris into a war zone. All...
  • cameron-doomedMoving Closer to BREXIT
      Polls Show Growing Support for a Break with the EU In the UK as elsewhere, the political elites may have underestimated the strength of the trend change in social mood across Europe. The most recent “You-Gov” and ICM pools show a widening lead in favor of a UK exit from the EU as the day of the vote comes closer.   Pro-BREXIT campaigners Boris Johnson (ex-mayor of London) and Michael Gove (UK Secretary of Justice) are in a good mood. Photo credit: Paul Grover /...
  • water houseA Market Ready to Blow and the Flag of the Conquerors
      Bold Prediction MICHAELS, Maryland – The flag in front of our hotel flies at half-mast. The little town of St. Michaels is a tourist and conference destination on the Chesapeake Bay. It is far from Orlando, and even farther from Daesh (a.k.a. ISIL) and the Mideast.   St. Michaels, Maryland – the town that fooled the British (they say, today). Photo credit: Fletcher6   Out on the river, a sleek sailboat, with lacquered wood trim, glides by, making hardly a...
  • The-answer-is-yesToward Freedom: Will The UK Write History?
      Mutating Promises  We are less than one week away from the EU referendum, the moment when the British people will be called upon to make a historic decision – will they vote to “Brexit” or to “Bremain”? Both camps have been going at each other with fierce campaigns to tilt the vote in their direction, but according to the latest polls, with the “Leave” camp’s latest surge still within the margin of error, the outcome is too close to call.   The battle lines are...
  • MACAU, CHINA - JANUARY 28: Buildings of Macau Casino on January 28, 2013, Gambling tourism is Macau's biggest source of revenue, making up about fifty percent of the economy.What Could Possibly Go Wrong?
      A Convocation Of Gamblers The Wall Street Journal and BloombergView have just run articles on the shadow banking system in China.  This has put me in a nostalgic mood. About 35 years ago when I was living in Japan, I made a side trip to Hong Kong.   Asia's Sin City, Macau Photo credit: Nattee Chalermtiragool   I took the hydrofoil to Macau one afternoon and the same service back early the next morning.  On the morning trip, I am sure that I saw many of the...
  • tree removal permit-1The Real Reason We Have a Welfare State
      From Subject to Citizen BALTIMORE – June 5th, the Swiss cast their votes and registered their opinions: “No,” they said. We left off yesterday wondering why something for nothing never works. Not as monetary policy. Not as welfare or foreign aid. Not in commerce. Not never, no how. But something for nothing is what people most want.   The future Switzerland just managed to dodge... for now   The Swiss voted against awarding all citizens a “universal basic...
  • saupload_loves-me-loves-me-notA Darwin Award for Capital Allocation
      Beyond Human Capacity Distilling down and projecting out the economy’s limitless spectrum of interrelationships is near impossible to do with any regular accuracy.  The inputs are too vast.  The relationships are too erratic.   The economy - complex and ever-changing interrelations. Image credit: Andrea Dionne   Quite frankly, keeping tabs on it all is beyond human capacity.  This also goes for the federal government.  Even with all their data gatherers and...
  • junkThe Problem with Corporate Debt
      Taking Off Like a Rocket There are actually two problems with corporate debt. One is that there is too much of it... the other is that a lot of it appears to be going sour.   Harvey had a good time in recent years...well, not so much between mid 2014 and early 2016, but happy days are here again! Cartoon by Frank Modell   As a brief report at Marketwatch last week (widely ignored as far as we are aware) informs us:   “Businesses racked up debt in the...
  • cameron at the EUBrexit Paranoia Creeps Into the Markets
      European Stocks Look Really Bad... Late last week stock markets around the world weakened and it seemed as though recent “Brexit” polls showing that the “leave” campaign has obtained a slight lead provided the trigger. The idea was supported by a notable surge in the British pound's volatility.   Battening down the hatches...   On the other hand, if one looks at European stocks, one could just as well argue that their bearish trend is simply continuing – and...
  • 7-bongo-bongo1Claudio Grass Talks to Godfrey Bloom
      Introductory Remarks – About Godfrey Bloom [ed note by PT: Readers may recall our previous presentation of “Godfrey Bloom the Anti-Politician”, which inter alia contains a selection of videos of speeches he gave in the European parliament. Both erudite and entertaining, Mr. Bloom constantly kept the etatistes of the EU on their toes.]   Godfrey Bloom, back in his days as UKIP whip Photo credit: Reuters   Before becoming a politician, Godfrey Bloom worked for 35 years...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com