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EU Lurching Towards Wave of Defaults

It's official: the EU's cure has made the patient sicker.

Last week Greece attempted to sell bonds with the new backing of the EU aid accord, which was supposed to show markets that the EU would prevent a Greek default, and get investors to accept lower rates on new Greek bonds due to perceived lower risk. However, the accord was too ambiguous to reassure bond buyers. See The EU Contingency Plan: Doomed By Its Main Strength for details.

As a result, Greece could not sell the bonds it wanted at rates it could afford.

Rumors arose that Greece wants to tap the funds available, but there is disagreement on what rates it will pay on borrowed funds, and under what conditions it can get them. Now markets are becoming convinced of what was merely suspected: that there is no clear EU stop against impending default in May if Greece can't borrow another 10 bln at more affordable rates.

Thus, rates are rising to even higher levels, not just for Greece, but for all the PIIGS block, ironically bringing them all closer to default, which in turn will send rates higher, and possibly spark a vicious cycle of ever rising fear sparking ever rising rates. If it isn't stopped, there's a risking risk of a chain reaction of sovereign default sparking still higher borrowing costs for other weak economies and thus further defaults, etc.

The process has begun.

Credit Default Spreads, a measure of the extra interest markets demand over and above that charged for uber-safe German bonds, are now at a new high of 467 basis points. That's an extra 4.67% over the roughly 2.5% paid on German 10 year bonds, bringing Greek borrowing costs to over 7%. Portugal's CDS also hit a new high yesterday.

The chart below notes recent increases in borrowing costs for not only Greece, but for virtually the entire PIIGS block plus much of the surrounding neighborhood.

Click to enlarge

Chart Courtesy of 03 apr 08

Note that CPD = Cumulative Percent Default risk. Thus per the chart, Spain and Italy have seen a 10%+ rise in their CDS, and now have a default risk of over 11% over the past month.

None of this is terribly new news, yet until today risk assets have managed to climb higher. Could we be at the beginning of the inevitable market drop if the PIIGS & Co. continue to lurch towards a wave of sovereign defaults that will dwarf the fear inspired by Lehman Brothers' collapse?

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Disclosure: No positions.