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!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

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:

  • How to Get Ahead in Today’s Economy
      “Literally On Fire” This week brought forward more evidence that we are living in a fabricated world. The popular story-line presents a world of pure awesomeness. The common experience, however,  falls grossly short.   There are many degrees of awesomeness, up to total awesomeness – which is where we are these days, in the age of total awesomeness, just a short skip away from the Nirvana era. What is Nirvana, you may wonder? We only know for sure that Nirvana is what...
  • Full Faith and Credit in Counterfeit Money
      A Useful Public Service There are nooks and corners in every city where talk is cheap and scandal is honorable.  The Alley, in Downtown Los Angeles, is a magical place where shrewd entrepreneurs, shameless salesmen, and downright hucksters coexist in symbiotic disharmony.  Fakes, fugazis, and knock-offs galore, pack the roll-up storefronts with sparkle and shimmer.   The Alley in LA – in places such as this, consumers are as a rule well served by applying a little bit of...
  • Gold and Gold Stocks – Conundrum Alert
      Moribund Meandering Earlier this week, the USD gold price was pushed rather unceremoniously off its perch above the $1300 level, where it had been comfortably ensconced all year after its usual seasonal rally around the turn of the year. For a while it seemed as though the $1,300 level may actually hold, but persistent US dollar strength nixed that idea. Previously many observers (too many?) expected gold to finally break out from its lengthy consolidation pattern, but evidently the...
  • US Money Supply Growth Jumps in March , Bank Credit Growth Stalls
      A Movie We Have Seen Before – Repatriation Effect? There was a sizable increase in the year-on-year growth rate of the true US money supply TMS-2 between February and March. Note that you would not notice this when looking at the official broad monetary aggregate M2, because the component of TMS-2 responsible for the jump is not included in M2. Let us begin by looking at a chart of the TMS-2 growth rate and its 12-month moving average.   The y/y growth rate of TMS-2...
  • Fear and Longing - Precious Metals Supply and Demand
      Waiting for Permanent Backwardation  The price of gold dropped 9 bucks, while that of silver rose 3 cents. Readers often ask us if permanent backwardation (when gold withdraws its bid on the dollar) is still coming. We say it is certain (unless we can avert it by offering interest on gold at large scale). They ask is it imminent, and we think this is with a mixture of fear and longing for a higher gold price.   Lettuce hope this treasure is not cursed... but it probably is....
  • Scorn and Reverence - Precious Metals Supply and Demand
      Shill Alarm One well-known commentator this week opined about the US health care industry:   “...the system is designed the churn and burn... to push people through the clinics as quickly as possible. The standard of care now is to prescribe some medication (usually antibiotics) and send people on their way without taking the time to conduct a comprehensive examination.”   From the annals of modern health care... [PT]   Nope. That is not the standard...
  • Global Turn-of-the-Month Effect – An Update
      In Other Global Markets the “Turn-of-the-Month” Effect Generates Even Bigger Returns than in the US The “turn-of-the-month” effect is one of the most fascinating stock market phenomena. It describes the fact that price gains primarily tend to occur around the turn of the month. By contrast, the rest of the time around the middle of the month is typically far less profitable for investors.   Good vs. bad seasonal timing...   [PT]   The effect has been studied...
  • Tales from “The Master of Disaster”
      Tightening Credit Markets Daylight extends a little further into the evening with each passing day.  Moods ease.  Contentment rises.  These are some of the many delights the northern hemisphere has to offer this time of year. As summer approaches, and dispositions loosen, something less amiable is happening.  Credit markets are tightening.  The yield on the 10-Year Treasury note has exceeded 3.12 percent.   A change in pace: yields are actually going somewhere. There is...
  • Is Political Decentralization the Only Hope for Western Civilization?
      Voting with their Feet A couple of recent articles have once more made the case, at least implicitly, for political decentralization as the only viable path which will begin to solve the seemingly insurmountable political, economic, and social crises which the Western world now faces.   Fracture lines – tax and regulatory competition allows people to “vote with their feet” - and they certainly do. [PT]   In the last few months, over 3,000 millionaires have...
  • Why the Fundamental Gold Price Rose - Precious Metals Supply and Demand
      Gold Lending and Arbitrage There was no rise in the purchasing power of gold this week. The price of gold fell $22, and that of silver $0.19. One question that comes up is why is the fundamental price so far above the market price? Starting in January, the fundamental price began to move up sharply, and the move sustained through the end of April.   1-month LIBOR (London Interbank Offered Rate – the rate at which banks lend euro-dollars to each other). LIBOR and GOFO...
  • “Sell In May And Go Away” - A Reminder: In 9 Out Of 11 Countries It Makes Sense To Do So
      A Truism that is Demonstrably True Most people are probably aware of the adage “sell in May and go away”. This popular seasonal Wall Street truism implies that the market's performance is far worse in the six summer months than in the six winter months. Numerous studies have been undertaken in this context particularly with respect to US stock markets, and they  confirm that the stock market on average exhibits relative weakness in the summer.   Look at the part we...
  • Gold and Gold Stocks – The Gloom Patrol
      Fun with Positioning and Sentiment Last week we discussed the gold sector “conundrum” – the odd fact that there is apparently quite strong demand for gold despite a macroeconomic environment that would normally be considered quite bearish for the metal. Gold recently seems to have lost its last remaining inter-market “ally” if you will, as the dollar has begun to enter an uptrend as well. Positioning data in precious metals futures are nevertheless rather remarkable, given the...

Support Acting Man

Item Guides

Top10BestPro
j9TJzzN

The Review Insider

Dog Blow

Austrian Theory and Investment

Archive

350x200

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

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]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com

Diary of a Rogue Economist