Greek, Irish, and Portuguese yields are at or flirting with new all-time highs.

Moreover, things are not looking pretty for Spanish and Italian bonds. Both trade at the upper end of their respective ranges yet German bond yields have fallen since the second week in April.

The prospect of a messy default in Greece is rising, even though it appears the IMF will hold its nose and give Greece another tranche of money.

Credit default swaps price in a 75% chance of default in 5 years. However, Investors Now Bet On a ‘Greek Accident’ Within a Year.

A new bet has been placed on the Greek debt crisis. It backs a growing view among investors that Athens may be about to suffer a messy default that could spark a run on the country’s banks and a deeper euro zone crisis.

One senior investor said: “There is a meaningful chance of a Greek accident this summer. That involves a hard default and big losses for investors, which could have very worrying repercussions for the euro zone.”

These fears have prompted bets on the so-called “accident scenario”, which involves buying one-year credit default swaps that would pay out big profits in the event of a hard default, typically a non-payment of loans, in the next 12 months.

Although these funds have placed only a small amount of money on these bets, the mere fact that they are using them highlights the growing risks for the euro zone.

Greek two-year bond yields, which have an inverse relationship with prices, lurched 160 basis points higher, one of the biggest daily moves of the year, to a euro-era record of 28.02 percent.

Greek five-year CDS leapt to a high of 1,700 basis points, or a cost of $1.7 million to insure $10 million of debt annually over five years. Greek CDS is also pricing a 75 percent chance of a default by the country over the next five years – it was about 45 percent at the start of the year.

Irish and Portuguese two-year yields and five-year CDS also jumped to record highs. More worryingly, Spanish and Italian bond markets were hit too, with Spanish bond yields closing in on highs last seen in 2000.

Inquiring minds may wish to consider some charts of 2-year sovereign debt yields.

2-Year Yield Germany – 1.47%

2-Year Yield France – 1.75%

2-Year Yield Italy – 3.05%

2-Year Yield Spain – 3.52%

2-Year Yield Ireland – 12.28%

2-Year Yield Portugal – 12.44%

2-Year Yield Greece – 28.15%

If there was no risk of default as ECB president Jean-Claude Trichet insists, there would be no investor preference for German bonds over Greek bonds, Portuguese bonds, or Irish bonds.

Instead there is a significant difference between German and French bonds and the bonds of every other country.

Spain is too big to bail and Italy is much bigger still. All hell is going to break loose when yields in Spain or Italy rapidly rise, and it’s only a matter of time before they do.

Spanish 10-Year bonds are flirting with disaster right now.

10-Year Yield Spain – 5.62%

German 10-year bonds are 2.95%.

A sustained move above this level spells serious trouble for Spain.

Greek Recap

Mike “Mish” Shedlock
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