Credit markets have a message for European officials wrangling with investors to cut Greece’s debt: You will get a deal, but it may not be the one you want.

The talks between Greece and private-sector creditors, which are set to resume in Athens on Friday, come as fresh data confirmed that Greece remains mired in recession and will overshoot its deficit targets this year, raising new obstacles to a proposed €130 billion ($166.6 billion) bailout for the country.


Trading in Greek bonds and credit-default swaps suggests that while investors are betting an agreement will be reached, some bondholders are unlikely to enter into it voluntarily. That could lead to a technical default under the arcane rules of the credit markets, an outcome that European officials have been working hard to prevent.

European officials have aimed for voluntary agreement in part because it allows Greece to avoid the stigma of officially defaulting on its debt. Such an agreement also would mean bondholders had no right to make any claims under credit-default swaps, which offer insurance-like protection for bondholders in the event of a default. Trading in these swaps, known as CDS, has been vilified by European officials who see them as the domain of unscrupulous hedge funds seeking to profit from the region’s troubles.

Expectations that a default still is in the cards can be seen in rising prices on Greek CDS. The cost of insuring $10 million Greek bonds for five years has risen to $7 million from $6 million over the past six weeks, according to pricing service Markit.

Traders say the higher costs of insuring against a Greek default reflects a growing belief that some bondholders, mainly hedge funds, won’t voluntary agree to the deal. Some hedge funds have been purchasing short-term Greek debt, angling to profit from delaying a restructuring agreement and triggering CDS payments.

Should the hedge funds not sign on to a restructuring, Greece may need to force holdouts into a deal. That turn of events would likely be considered a default under the rules of CDS contracts and trigger a payout of the swaps.

Regardless of the possibility of hedge-fund holdouts, Greece is focusing its efforts on banks and asset managers, which own the majority of the bonds.

Those talks are entering their final stages, but key areas remain unresolved, people involved in the discussions said on Thursday. Pressure is rising to reach an agreement in time to be implemented before Greece has to pay holders of €14.5 billion ($18.6 billion) of bonds maturing in March.

“We are quite concerned about the lack of a clear process,” said Charles Dallara, managing director of the Institute of International Finance, which is negotiating on behalf of more than 400 banks. “All parties really do need to come together here…and it has to be done in the next few days.”

A senior Greek finance ministry official said the talks are “on track” and that a final outline may be reached by the end of next week.

Officials are pondering whether to add sweeteners to help convince investors to agree to the deal, under which many would have to take big losses. Under the current proposal, bondholders would accept an exchange of old bonds for new ones with maturities ranging between 20 and 30 years and a coupon of 4% to 5%. The exchange would slice roughly €100 billion off Greece’s total public debt—50% of what it owes private creditors.

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