Impact of Greek Troubles

Greece has been in the news again recently. The 5 year credit default swaps have jumped from 344 basis points last Friday to 444 basis points today, surpassing Iceland as the most worrisome sovereign debt in Western Europe. One hundred basis points in one week is a relatively large move, so it is expected that the impact of a worsening situation in Greece should impact both currency and equity markets. 

The more trouble Greece is in, the more people worry about the future of the Euro. However, it doesn’t take a probability of a currency crisis to drive the currency lower; it only takes an expectation of a relatively weak monetary policy in Europe to support Greece.

The worry that the Greek crisis will spill over into the financial system, along with its effect on the currency, has made the S&P outperform the Euro Stoxx 50 in dollar terms whenever Greece’s CDS spikes.

The rolling two month differences correlations have been relatively steady at 0.2 and 0.3 for the past 4 months (0.4 and 0.5 when looking at financial stocks). There are obviously other factors affecting currency and relative equity market performance, but the change in Greek CDS has been having a definitive impact. Those who don’t like trading the Greek CDS directly might consider a currency hedged long short equity approach.