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Growth, not Greece, is fueling the market

On the margin, the news about Greece has been positive, with the government agreeing to austerity measures in order to receive financial assistance. But the market continues to believe that a default (or restructuring) is highly likely, as the above chart shows. Yields on 2-yr Greek government debt have declined marginally, but they are still high enough to equate to a high probability of a significant loss of principal. This can also be appreciated by looking at the price of credit default swaps on Greece, which as of yesterday traded at 2100 bps.

So while the Greek situation looks less dire, it still promises to be painful for many, and the fundamental problem (i.e., grossly inflated public sector spending) is far from being resolved.  Markets understand this. So the impetus to the rally in U.S. equities is likely mostly due to news which suggests the economy is pulling out of its recent slump. A resumption of stronger growth in the $15 trillion U.S. economy easily trumps whether or not Greek bond holders lose a few hundred billion.

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