Sunday, 24 July 2011

Macro and Markets update - Peripheral debt - Rally Monkey!

Friday saw some massive tightening in the two years segment of Periperal government bonds:
Nope, not a typo, thanks to the European "n" plan to tackle the issues with Greek Sovereign debt in particular, and peripheral debt in general, 2 year Greek bonds rallied strongly by 614 bps when I took this snapshot. At some point they even rallied 800 bps! Portugal 2 year notes as well tightened by 184 bps and Irish two year bonds by 419 bps on the day.

On the 10 year segment for European Government bonds, the action was more muted:
Greek 10 year bonds tightened by 175 bps, Portuguese bonds by 72 bps and Irish 10 year bonds by 44 bps.

On the Sovereign CDS space, the action was more radical on the 5 year segment, the most liquid part of the market:
GREECE 1440-1650 -250 bps tighter      upfront market quote 39/42
SPAIN 305/315 +2 bps wider
IRELAND 850-900 -40 bps tighter                   
PORTUGAL 880-940 -10 bps tighter                   
(source, one dealer run).
The all time high for Greece was 2,568 bps on the 18th of July.

Credit Indices as well were tighter accross the board:
From its recent high of 309 bps, SOVx index has now tightened to 260 on the year point which is not surprising given the tightening move we have seen for some of its members (Greece, Portugal, Ireland).

According to Fitch, Greece, faces a "Restricted Default" following the meeting held on the 21st of July which comprise a new plan of 159 billion euro. It requires private bondholders to assume part of the cost. The proposed plan implies a 20% net present value loss for banks and holders of Greek Government debt.
The new plan is made of 109 billion euros from the Euro-zone and the IMF, and 50 billion euros coming from financial institutions, with bond exchanges and buy backs, which is expected to reduce the debt burden for Greece. The EFSF 440 billion euro fund will be able to buy debt accross the peripheral countries and aid troubled banks with credit-lines.

So, will we have a credit event, triggering pay-off for Greek Sovereign CDS protection holders?
The International Swaps and Derivatives Association said participation of private bondholders in the Greek rescue plan "should not trigger credit-default swaps" because it is "expressly voluntary" according to David Geen, ISDA's general counsel in London.

More on the new European plan:
Greece will receive loans from EFSF at rates close to swap rates but not below the EFSF funding costs (expected to be around 3.5% - 3.7%) for 15 years or longer. Coupon will therefore be lower on bonds, and the maturities extended. This is indeed more positive given that the average interest rate on all debts will be lowered, which will imply Greece to run a smaller primary surplus to stabilise its debt. Overall its alleviates the debt pressure on the Greek economy, but doesn't fully resolve the solvency risk.
In relation to the EFSF size, markets are already questioning the fact it has not been increased to keep the fund in a position to rescue Spain if needed.
The big unknown in the new plan lies in the private participation rate which is assumed to be as high as 90%. Nothing, so far has been explained on how this participation rate will be achieved.

It is another successful "kicking the can dow the road" solution. It doesn't fully address necessary debt relief in the near future, but tries to avoid at all cost a triggering of sovereign cds payments by involving the private sector in a "voluntary" way with the support of ISDA (so much for buying CDS for an accident which is happening, but is not "really" happening since the private sector is willing to participate...). Conclusion, when you don't like the rules relating to credit events, just change the rules...

Moral of the story: "If you can't win the game, change the rules".


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