April 22, 2015 / 2:26 PM / in 4 years

UPDATE 2-Greek markets point to exit panic but euro zone keeps its cool

(Updates throughout)

By Marius Zaharia

LONDON, April 22 (Reuters) - Greek debt markets are close to fully pricing in another default and fears that Athens might leave the euro zone have reached new heights, but there is no obvious sign that investors expect a spillover to the rest of the region.

The head of Eurogroup finance ministers, Jeroen Dijsselbloem, the International Monetary Fund’s European head, Poul Thomsen, and a White House adviser have warned in the past week that a Greek exit would lead to instability.

Yet financial markets do not seem, for the moment, to be concerned that a so-called Grexit could tip other indebted countries out of the 19-nation currency area.

The European Central Bank’s trillion euro asset-buying programme, launched to revive inflation and a stagnant economy, has emboldened investors to tolerate more risk. They also feel reassured by euro zone safety nets including a bailout fund, a mechanism to deal with troubled banks and a promise by ECB chief Mario Draghi to do “whatever it takes to preserve the euro”.

In contrast to the height of the debt crisis in 2012, when Grexit fears spurred panic selling of other weak euro zone sovereigns, investors now seem relaxed about the fate of Greece, which accounts for just 2 percent of the region’s economy.

“The market is on a very powerful anaesthetic from central banks so this keeps contagion very low,” said Alberto Gallo, head of European macro credit research at RBS.

To avert a default this month, Greece has been tapping into public reserves in temporary transactions and has ordered various state entities to park idle cash with the central bank.

These measures should allow Athens to meet its debt obligations into June.

The move has halted the rise in yields in Greek bonds, but they remain sky high. Two-year bonds, which were issued last year with yields below 4 percent, last yielded 28 percent. Ten-year yields were 13 percent.

“There’s a bit of respite, but nothing to be cheerful about,” said Gianluca Ziglio, an analyst at Sunrise Brokers.

Trading has dried up. Data from the Greek central bank shows zero volumes on the HDAT electronic platform between March 27 and April 15. Only 63 million euros were traded last month. Total volumes for 2014 were 10.4 billion euros.

This suggests the little remaining trading in Greek bonds is being conducted over the counter, probably between “vulture funds” specialised in investing in distressed markets.

Bookmaker William Hill closed bets on a 2015 Grexit a week ago.

DEFAULT PROBABILITY

Greek five-year credit default swaps trade at more than 2,600 basis points (bps), implying a default probability of almost 90 percent, according to data from Markit.

That compares with 8.8 percent in Spain, 11.5 percent in Italy and 13.5 percent in Portugal. In 2012, by contrast, the threat of Grexit pushed default probabilities in indebted peripheral euro zone countries to between 40 and 60 percent.

Three sources familiar with ECB thinking denied a New York Times report that the bank had demanded the value of collateral Greek banks post at their central bank to secure emergency loans be cut by as much as 50 percent.

The ECB raised the cap on emergency funds that the banks can borrow from the Bank of Greece by 1.5 billion euros to 75.5 billion euros on Wednesday, a banking source said.

Analysts are sceptical of any move to further haircut collateral as it would be tantamount to pulling the plug on Greek banks, which have suffered a huge loss of deposits. An index of Greek bank shares rose 8.5 percent.

“An actual limitation of the Emergency Liquidity Assistance is unlikely, as this would have consequences that are not desired politically,” said Alexander Plenk, head of investment research at Bayerische Landesbank.

Greek Finance Minister Yanis Varoufakis said on Tuesday he did not expect a deal at a meeting on Friday of euro zone finance ministers, but that an agreement would eventually be reached.

CASH FLOWS

Yields on Spanish and Italian bonds both fell 8 bps to 1.39 percent as investors anticipated about 65 billion euros of French, Italian and Spanish debt redemptions and coupon - regular interest payments - would be reinvested in the two relatively high-yielding markets.

Last week, when Spanish and Italian yields rose about 20 bps, was the busiest week of the year so far for debt sales.

The wide moves on cash flow fluctuations show Grexit concerns have only limited influence on peripheral markets.

“We saw a little bit of pressure last week which was a combination of Greek worries and supply indigestion but ... there’s very little evidence of Greek contagion,” said Nick Stamenkovic, bond strategist at RIA Capital Markets.

As soon as the debt redemptions and coupon payments come back to the market, investors will be competing with the ECB for bonds, analysts said. link.reuters.com/myx54w ($1 = 0.9297 euros) (Additional reporting by John Geddie; Graphics by Vincent Flasseur; editing by Nigel Stephenson, David Stamp and Paul Taylor)

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