Is Citi's "grexit" probability too high?

It is clear that Greece will need some form of debt restructuring, and the Eurozone leadership seems to be committed to getting that done (see discussion). Given the lack of cohesion, the Eurozone may just need a bit of a push from the markets in order to reach a consensus. But many still believe that not only will Greece need restructuring, but it will also exit the EMU as soon as next year. Citi research for example has assigned a 60% probability to "grexit".

CNBC: - "In Greece, debt restructuring is unavoidable whether Greece exits the euro area (our base case, with a 60 percent probability in the next 12-18 months) or not," Citi said. 

This probability figure feels quite high - particularly given that Germany seems to be committed to keeping Greece in (because they fear the "domino effect"). In spite of these forecasts, the prediction markets seem to be saying something very different. The latest Intrade odds for "grexit" by the end of 2013 are close to half the figure from Citi.

Any country currently using the Euro to announce intention to drop it before midnight ET 31 Dec 2013

Those who believe Citi's forecast should be buying this contract right now. So far however those who bet on this event seem to prefer selling the contract.

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Intrade and electoral votes still show Obama in the lead; economy will drive odds going forward

After a sharp decline, the Obama victory odds on Intrade seem to have have stabilized at around 63% (chart below). The betting market was pricing in a poor performance by Biden (who has been known to "put his foot in his mouth"), which by most measures was not the case last night.

Once again, in spite of Romney leading in the major polls (Gallup: +2, Rasmussen: +1, IBD/TIPP: +1, Monmouth: +1), Obama continues to lead in the projected electoral votes - which is what Intrade reflects. Welcome to a republic.

Source: RealClearPolitics.com

Going forward the debates will become less impactful, as was the case during the Republican primaries. At this stage the focus is going to be almost entirely on the economy (as has been the case with most incumbents historically - has little to do with ideology, etc.). Economic data thus far has been helping the Obama camp (although another spike in gasoline prices could do some real damage). The recent jobs data (whether real or not; discussed here and here) as well as today's sharp increase in consumer confidence to the pre-recession levels (see Lee Adler's discussion) explains why the president's odds are still at these levels. Broader economic measures point to this fact as well, as reflected by a steady climb of the Citi Economic Surprise Index (discussed here).

Citi Economic Surprise Index

According to a number of economists the sharp decline in orders last quarter (discussed here) may have been a Eurozone induced "air pocket".

JPMorgan: - ... it looks most likely that last quarter’s sharp declines in capital goods orders represents an air pocket that will be followed by a lift back toward cruising altitude into year-end.

As difficult as things still are for the US consumer, American economic activity continues to be ahead of the global averages. And as long as these economic trends stay intact, the president will retain his lead, at least as measured by the betting markets.

Source: JPMorgan

Update: Here is the latest chart from DB that shows the probabilities of various elections outcomes:

Source: DB

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Intrade paths to the White House

Understanding voter dynamics is both a science as well as an industry. But direct voter surveys often don't  tell us much. The chart below shows poll numbers of voter preferences for Obama vs. Romney. Except for some movement is April, the numbers indicate a very close race  (with a plus or minus 3 percentage points). Not very informative.

Source: Bianco Research (click to enlarge)

In situations like these its helpful to turn to the betting markets like Intrade. The next chart shows Intrade probability of Obama winning the 2012 election compared with two previous probability charts that led to presidential victory.

Source: Bianco Research (click to enlarge)

The president's reelection chances are now lower than his own chances 4 years ago and even Bush's reelection probability 8 years ago. What this tells us is that even though Obama is still more likely to win (by a narrow margin), his path to the White House is far less certain.

Update: One of the reasons Obama continues to be ahead of Romney on Intrade has to do with his Electoral College advantage. Those who vote with their dollars are more likely to perform this type of analysis before making their bets. Take a look at the following table from ISI:

Source: ISI Group (click to enlarge)

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The unreliability of political polls in assessing election odds

There is a disconnect between polling signals we are seeing on Obama's candidacy for the second term and what the markets are telling us. The latest polls have Obama disapproval rising to 50%. Rasmussen polls have Romney ahead of Obama 46-43 in a head to head contest. And rising gasoline prices seem to be the key issue behind those disapprovals.

Washington Post: Disapproval of President Obama’s handling of the economy is heading higher — alongside gasoline prices — as a record number of Americans now give the president “strongly” negative reviews on the 2012 presidential campaign’s most important issue, according to a new Washington Post-ABC News poll.
...
Gas prices are a main culprit: Nearly two-thirds of Americans say they disapprove of the way the president is handling the situation at the pump, where rising prices have already hit hard. Just 26 percent approve of his work on the issue, his lowest rating in the poll. Most Americans say higher prices are already taking a toll on family finances, and nearly half say they think that prices will continue to rise, and stay high.

Gasoline prices have certainly risen, as the futures chart below shows.

Unleaded gasoline futures

But so have the odds of Obama being reelected on Intrade in spite of all the polls. The odds are now at 61.4%, the highest since May of 2011. There doesn't seem to be any evidence that gasoline prices are hurting Obama's chances (so far). People often have a visceral reaction to these types of Intrade odds, particularly if it goes against their political views. However, like in any market, those who don't agree with it can bet against it (for example if you don't like the Dow at 13000, you should sell/short it.) So far that hasn't been the case with these Obama contracts.

Obama reelection odds

What this means is that gasoline prices are aggravating poll respondents who give Obama a high disapproval rating. But if asked who they would bet money on (effectively who is most likely to be elected, not who they would vote for), the answer (if answered sincerely) would be Obama 61% of the time. This once again points to the unreliability of political polls when it comes to assessing election odds.

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Ron Paul ahead in Iowa as Intrade is jammed

Intrade, the "wisdom of crowds" is completely jammed as volumes spike in Iowa caucus betting. This happened before particularly during election surprises or close calls, but obvously the problem has not been resolved. Participants will quickly lose faith in the market if they have trouble unwinding positions during the most volatile periods.

But if you are patient enough, for a brief time you may see Ron Paul ahead of the competition.  Not clear if this is at all sustainable (the lead is likely to fade), but it certainly is surprising. Even if Paul doesn't progress from here, this is still quite a victory for the US Libertarians. This group was viewed as a fringe movement just a few years ago but now has entered the mainstream.

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What the market is telling us about Newt Gingrich

When it comes to the Republican nomination, all the wonderful polls out there are printing different numbers, but there is no poll like the market. And the market is showing Newt Gingrich probability of nominations rising sharply approaching 40%.

At the same time Intrade has Mitt Romney contracts selling off. 

If this continues we may have a Republican surprise shortly.   This would throw a wrench into the General election odds because it's unclear if Gingrich could take on Obama.

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Trouble for Republicans?

Looks like Republicans may be in trouble for 2012 presidential bid.  Intrade, the Irish betting site has Obama above 51% odds of victory with an upward trend.   Seems the Republican presidential debates and the “personalities” lineup didn’t help much.  There is also some evidence the Democrats' performance (probability) is correlated to the equity markets.  But more on that later.

When people bet money on a candidate, they are not saying this is who they would vote for, but who is more likely to win.  That makes this process a better predictor than traditional polling.

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