Leveling the Playing Field

June 29, 2015

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Well, that was an interesting week. Treasurys sold off on the long end of the curve, with the 10T
rising more than 20bps on the week before closing Friday at 2.47%. Continued strength in
domestic data, led by consumer spending and housing, served as the catalyst for the move.
Couple this with rumor after rumor about positive (yet unsubstantiated) news out of Greece, and
the result was an appetite for risk.
Heres the thing Greece isnt even resolved. A 0.20% jump in rates at the very moment the
Greece bailout is negotiated continues to shock surprise us. Weve been complaining for months
that the market was underestimating the possibility of a Grexit, which was pricing in almost a
0% chance of a Greek default. We didnt think a Greek default was likely, but it was certainly
more than 0%.
Then this weekend happened. Tsipras ended negotiations with the ECB and IMF, turning down
the terms of the bailout package to release 7.2 billion because of the severe taxes and austerity
measures attached to the funds. Tsipras said he would recommend to the Greek public that they
vote against the measures in a referendum on July 5th. Tsipras called for the referendum
Saturday and the Greek Parliament approved it yesterday. Tsipras requested, and was denied, a
one month extension of the emergency bailout negotiations by the Eurozone Finance Committee.
Sh8t just got real (my grandmother reads this, so I couldnt swear outright).
Before the vote on July 5th (and lets assume the outcome is a resounding no), Greece is due to
make a payment of 1.5 billion on Tuesday, funds most believe the country does not have.
Assuming it does not make this payment, Greece will become the first developed nation to
default on a payment to the IMF.

Greek Default
Assuming Greece defaults on its payment Tuesday, it doesnt mean financial markets collapse on
the spot. None of our readers defaulted on loan payments during the crisis, but I have heard
anecdotally that a few commercial real estate loans defaulted during that time period. One
month payment falling into arrears doesnt mean the bank loses the entire loan amount on the
spot. Same thing here. Its more about the principal (pun intended) of it.
But Im not sure how much planning Greece has done to unveil its own currency, which it would
need in order to exit the euro. Tsipras has only been in office late January and his hands have
been pretty full trying to negotiate a new deal.

Just as importantly, the ECB will have a tough time extending its ELA, set to expire Tuesday as
well, to Greek banks at the same time the government is in default to the IMF. I bet most Greeks
spent the weekend running around to ATMs trying to withdrawal as much money as possible. If
Greek banks open Monday (and they might not), there could be limits on withdrawals.

No matter how many times I try to warn my kids about one thing or another, sometimes they just
need to endure a little bit of pain to really learn the lesson, and I wonder if the same applies here.
The Greek banking systems is about to endure quite a burden, and perhaps Lagarde, Draghi, and
Merkel are like the parents that finally throw their hands up and say let me know how that
works out for you. What is Tsipras Plan B? Youve got no currency, no credibility, and no
contingency. Your leverage is basically Things are so bad here that they cant really get much
worse, but can you guys really afford for us to default?

Is the Eurozone Insulated from a Default?

Which leads us to the surprising rate movement last week. My gut is that US yields have to
come back down Monday morning, but perhaps the selloff tells us something about the market
sentiment towards a default. The market is either underestimating the possibility of default OR
thinks the damage can be contained.
Greece has been struggling mightily for five years, and during that time the ECB has been hard
at work injecting liquidity into the financial system. Most European nations are doing better and
the Draghi Put has backstopped most peripheral exposure. Greek debt has slowly but surely
been transferred from banks/investors to central banks in the form of collateral for loans. Maybe
the market just isnt that concerned with a Greek default anymore.
At a minimum, we feel like this has to keep a lid on yields while markets digest the possible
outcomes. More likely, we would expect US rates to retrace the movement last week. The
current range on the 10T is 2.30% - 2.50%. A break through the key psychological level of
2.50% seems unlikely without a positive development in Greece, while a sharp move towards
2.30% or lower suggests the market was caught off guard by the failed negotiations.
Markets are closed Friday for the Independence holiday maybe Greece will be declaring its
own independence from the euro soon? Domestically, lots of data headlined by Thursdays job
reports. Market expectations are for a gain of 230k jobs, but any rate movement will be dulled
by whatever is happening in Greece. The job data will, however, shape the framework for a Fed
hike timetable.

Economic Data
Day

Time

Monday

10:00AM
10:30AM
9:00AM

ISM Milwaukee

47.7

9:00AM

S&P/Case-Shiller US HPI MoM

0.12%

10:00AM

Consumer Confidence Index

97

95.4

7:00AM

MBA Mortgage Applications

1.60%

8:15AM

ADP Employment Change

211K

201K

10:00AM

Construction Spending MoM

0.60%

2.20%

10:00AM

ISM Manufacturing

53.1

52.8

8:30AM

Change in Nonfarm Payrolls

230K

280K

8:30AM

Unemployment Rate

5.40%

5.50%

8:30AM

Initial Jobless Claims

270K

271K

8:30AM

Continuing Claims

10.80%

8:30AM

Underemployment Rate

2247K

8:30AM

Labor Force Participation

62.90%

9:45AM

Ism New York

54

10:00AM

Factory Orders

-0.50%

-0.40%

Tuesday

Wednesday

Thursday

Report

Forecast

Previous

Pending Home Sales MoM

1.50%

3.40%

Dallas Fed Manfufacturing Activity

-16.8

-20.8

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