Why would you not buy Greek bonds? Olli Rehn has said that the PSI level will be 50%, although a final agreement has yet to be announced. According to Bloomberg, the Greek bond that matures in March trades below 50. Even if you have to participate in the PSI, you should make money. Further, March is probably too soon for a forced restructuring to be agreed; and even if a collective action clause can be put into the bonds in time, it would be unlikely to be triggered if the ECB has a significant holding. I am trying to check on this last point. The downside on this trade seems both unlikely and limited — say, a hastily agreed forced restructuring with a 60% writedown, which would take the value of the bonds to 40 (on a back-of-an-envelope basis). On the upside, there is a good chance of getting repaid at par in March.

I mentioned another bond trade last week: short US 10-year Treasuries. I am going off this idea in the short term: rates implied by interest-rate futures are still falling further out on the curve (e.g. Dec 2014) and it seems likely that the Fed’s new interest-rate path predictions will suggest that rates will stay at zero beyond the summer of 2013, which could push implied rates down further. This is all bullish for 10-year treasuries. If this combination of things fails to push 10-year yields below their recent range, however, that would be the time to put on a short.

Is risk on-risk off dead? Equities are rising in the US, UK and Brazil, rising more slowly and still downcast in Europe and Asia, and languishing in Japan. AUD is strong, but so are USD and JPY, and EUR, GBP and CHF look weak. Treasuries and Bunds remain at their highs. Rate expectations are falling in the US and Europe. Metals (industrial and precious) remain a long way down but have been rising since the New Year; WTI is strong while Brent remains elevated but is not challenging 120, the level it touched several times in the Spring of last year, and is basically flatlining. It seems that markets are — shock — being driven by market-specific factors and not global risk on-risk off. This provides opportunities but also a change of methodology, as I have been analysing everything using the risk on-risk off model for some time.

What are the implications of my view that the euro crisis has abated for the time being? Equities may have room to rise if the economic backdrop remains supportive — which I expect it to in the US. Might European equities also benefit, or will the recession keep them downcast? EM equities may not benefit because a European recession will be the big problem for them, not the threat of Eurozone breakup. A long position in European banks is an obvious play — if the banking system no longer looks at risk of collapse, banks should benefit. A long position in sovereign credit would also be a good idea, but the move may have already happened. A short in short-dated German bonds might make sense: perhaps the demand for high-qualilty collateral will abate if the banking system is well-funded by the ECB. A short in Schatz futures?

Finally today, Goldman Sachs has published its latest projection for the effect of US fiscal policy. Fiscal drag will be significant, at an annualised 75bps per quarter through 2012 assuming the various expiring measures are extended. This is likely to keep US growth lukewarm at best through 2012.


Beige Book: expansion improved last month in most districts; limited permanent hiring; housing remains sluggish.
Eurozone final GDP Q3 0.1% vs. 0.2% previous estimate.
China CPI 4.1%. Talk of the Chinese having room for easing is rampant.
UK manufacturing production -0.2% d.e. Nov.
UK IP -0.6% d.e. Nov.

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