I find myself still thinking about Greek bonds. The latest thing to worry the market is the “breakdown” of talks on public-sector involvement (PSI — a.k.a. voluntary restructuring). I am not sure how real a “breakdown” this is — it seems that a 50% writedown in face value has been agreed, and the outstanding questions are the maturity date and the coupon of the new bonds. On the latter, it seems that the IMF wanted a coupon of 2%, for the sake of reducing Greece’s government outflows, but that would mean a huge NPV write-down for holders of the debt. The EU wants 4% and the IIF is reportedly prepared to accept 4% initially with an uplift later. It is in the context of these negotiations that I think one should understand the IIF’s statement that it has “paused for reflection on the benefits of a voluntary approach” and the Greek government’s flirtation last week with the idea of adding collective action clauses to its bonds (on which it has since rowed back). I suppose it is possible that the parties, having been flexible enough to get this far, have suddenly dug into entrenched positions; more likely, each side needs to reinforce its negotiating position as the terms of the agreement are finalised. That is what I suspect is going on. The IMF has said that it will disburse its next tranche of aid to Greece if there is enough PSI, or, if there is not enough PSI, if European governments make up the shortfall. That means that EU governments and the IIF are the players with both power and skin in the game. If EU governments are prepared to accept a 4% coupon and the IIF will accept 4% with a later uplift, that looks to me like a deal that can be done.

This impression is reinforced by the observation that PSI is really the only game in town. A messy default would be in nobody’s interest, and a partial default (just on the March bond) would have unpredictable consequences. A compulsory restructuring (with those Greek collective action clauses inserted into the bond documentation) would:

  1. take time to arrange,
  2. have to happen in face of strong opposition from the ECB,
  3. if the ECB’s holdings were exempted, reduce the effectiveness of future ECB purchases of government bonds (by making any bonds purchased by the ECB super-senior — the remaining bonds in the market should suffer because their credit quality would decline),
  4. if the ECB’s holdings were not exempted, possibly mean capital losses for the ECB,
  5. mean that some non-Greek banks might need bailing out,
  6. choke off IMF and EU funding for Greece and hence plunge the economy into a tailspin and
  7. leave the EU’s strategy for dealing with the crisis in tatters.

The market seems to be assuming that the PSI talks will fail, but it strikes me that all the players have a strong incentive to make sure that they succeed. In that connection, Greece’s finance minister Venizelos has said that he is seeking to agree a framework for an agreement this week, in order to present an outline plan to the ECOFIN meeting on 23 Jan, and to announce the details of PSI between 6 and 10 Feb.

Moving onto other things, I notice that there was a jump in the Fed’s balance sheet in mid December. I presume that this relates to the European currency swaps. Whatever the reason, it will mean that more liquidity support has been provided to the US economy.

Data:

US trade deficit widened, d.e., Nov.
US import prices -0.1% mom Dec. Price increases have been subdued since May 2011.
US prelim. Michigan sentiment 74 b.e. The index has reversed all of its 2011 decline and is now extremely bullish (for the post-crisis period).
Japan core machinery orders 14.8% mom b.e. Volatile series but this is not a bad number.
Australia home loans 1.4%. Have been growing since early 2011. The Australian boom continues.

This Week:

Tue: China — a rash of implausibly early data, including Q4 GDP; UK CPI; Eurozone ZEW surveys and CPI; US Empire State index.
Wed: UK employment data; US PPI, TIC, capacity utilisation and IP.
Thu: Eurozone current account; US building permits, housing starts, CPI, initial claims and Philly Fed survey.
Fri: China HSBC flash PMI; UK retail sales; US existing home sales.

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