MBS Day Ahead: Europe no Longer Fears Dominoes; Up to Greece to Fold

Things began to change in the Eurozone in 2013.  That was when Cyprus and Italy were providing mild aftershocks following the bigger drama in 2010-2012.  Italy certainly had it's fair share of drama during that time, but if any Eurozone state takes the cake in terms of drama, it would have to be drama's birthplace itself.

Greek drama noticeably lost its luster in mid 2012 when it came to freaking out its neighbors.  Before that, the fear of a systemic (think dominoes) collapse was a real trading motivation for investors when it came to valuing the sovereign debt of other Eurozone countries.  Whoever was seen as the next most likely to follow Greece was who got hit the hardest.

I've marveled, recently, at the willingness in the analytical and media communities to go right back to that same old systemic conclusion.  CNBC even had some kid from Spain (he's actually a year older than me I think, but still...) on talking about the political party he's running (Podemos) and its parallels to Greece's Syriza party. 

Unfortunately, this is an example of an old idea that used to be valid, subsequently being resurrected as a much needed talking point for people that don't specialize in original thought when it comes to weird and confusing foreign economic matters.  Hey! That's totally forgivable!  I don't specialize in that stuff either, but let's at least sprinkle in a bit of due diligence on this whole domino thing.

I don't doubt that there was some legitimacy to the domino fears in the past, but right now, the rest of Europe just doesn't give a damn.  This is readily seen in the chart below where the various lines are other European countries' 10yr yields vs Germany's.  The farther they are from Germany (higher on the chart), the more risky they are.  Basically, this was/is a sovereign default and/or Eurozone exit barometer. 

What this means is that Greece doesn't have the ultimatum power it once had.  With QE in place, Europe is much better insulated against the systemic dominoes.  And frankly, who would want to leave right now unless they were forced to?  None of these supposed domino nations would make any rash decisions before seeing how things turn out for Greece, and if Greece leaves, the word on the street is that things will be bad... for Greece.

Add to that the fact that the Eurogroup wouldn't want to send the message that they could be easily extorted.  Really, the only way for Greece to catch a break from Germany would be for Germany to have a surprising change of heart, purely for humanitarian reasons.  Unfortunately, the longer term implications of such empathy could be even worse than no empathy at all, so we can't expect much of a concession.  OK, this is getting a bit confusing.  Suffice it to say "they clearly can't choose the wine in front of them!"

What's important is that the points I'm making are already well-known by the smartest guys in the room.  They would be surprised if Europe blinks and not-at-all surprised if Greece folds (gives up more ground than they said they would in order to stay in the Eurozone).  Yes, Greece would have a hard time selling that to their people, but their people also want to stay in the Eurozone.  This is the scenario that is mostly priced in.  If Europe gives much ground, that's NOT priced in, and it could cause significant volatility--probably for the worse, but the paradoxical effect could be fear that they've opened a can of worms (so they clearly can't choose the... oh nevermind).

Why are we talking about all this?  Because headlines may come out today that clarify the situation.  It would be a surprise to see any major milestone, but not impossible.  We're also talking about it because Greek credit spreads correlate awfully well with mortgage rate movement when Greece is in the spotlight.  Sounds crazy right?  But look at this chart of Fannie 3.0 MBS prices and the same old Greek credit spreads from the chart above.