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Soft restructuring, “reprofiling” – new terms for an old problem: Some EMU finance ministers and the EU Commission have proposed a soft restructuring of outstanding Greek government bonds. Conditional on further progress in the usual areas (austerity, structural reforms, privatization), Jean-Claude Juncker proposed reprofiling Greek debt maturities on a voluntary basis.
While the terminology isn’t fixed in any textbook, the following definitions might apply: Restructuring: change of terms including nominal. Soft restructuring: change of terms excluding nominal (i.e. maturity, coupon). Reprofiling: change of terms, but only maturity. It is, however, still not perfectly clear, whether a voluntary reprofiling would constitute a credit event, or a default, something all EU officials are trying to avoid.
The ECB threatened to not accept restructured bonds as collateral. The central bank strictly opposes any form of debt restructuring for a variety of reasons (it eases the pressure on Greece to re-form; it carries the risk of contagion; it carries the risk of portfolio losses on the ECB’s books; it threatens the independence of the ECB; it does not solve Greece’s debt problems). However, threatening not to accept restructured Greek government bonds is a double- edged sword: on the one hand, the ECB does not intend to monetize debt of a country in default; on the other hand, the ECB is obliged to guarantee financial stability.
Over the weekend, politicians weakened their call for a soft restructuring: Jean-Claude Juncker argued that a soft restructuring should only become an option once Greece’s (primary) budget is consolidated. Wolfgang Schäuble listed no less than four conditions for a soft restructuring: private investors need to be involved; the ECB must support the idea; Greece must redouble its efforts; and there needs to be a “sufficient guaran-tee” that Greece’s debt is sustainable. Only once these four conditions are fulfilled could one discuss the option of soft re-structuring, Schäuble elaborated. The outcome of the dispute remains completely open. Investors are confused and nervous.
After a moderate recovery period, EUR-USD dropped by another two cents to 1.4150 on Friday. Fitch lowered its rating on Greece by three (!) notches from BB+ to B+ (watch negative) and stated that voluntary debt rescheduling would be consid-ered a default. Greek bond yields rose. Spanish bonds also came under pressure, but less so from contagion effects but rather following genuine concerns: at auctions of long-term bonds, demand fell short of expectations. Public unrest intensified in the run-up to regional elections on Sunday. Spanish bond spreads widened by 25-35bp during the week. EMU debt con-cerns reached their climax on Friday midnight when S&P lowered its outlook on Italy’s A+ rating from stable to negative.
The rating agency justified its decision with “weak growth prospects” and the increased risk that Italy would fail to slash its debt mountain. There has been much discussion about the timing of rating agency actions in the past, which have been criticized as unjustified in most instances; but this rating action probably comes at the worst of all moments: it is absolutely imperative that Spanish and Italian government bonds are isolated from developments in the Greek, Irish and Portuguese bond markets. With Spanish bond spreads under genuine widening pressure and Italian bonds in the stranglehold of the rating agencies, the next few trading days might once again become a challenge for the euro. In the background, investors examine every single piece of economic data to stress-test their growth outlook.
In the US, last week’s data disappointed in this regard: the Philly Fed index, industrial production and housing data were all below expectations. This week, EMU business sentiment indica-tors (PMI, Ifo) are expected to confirm the view that the peak in economic activity lies behind us. While there’s no reason to be afraid of the impending cyclical economic moderation, core government bond yields are facing a hard time moving to higher levels that would appear to be appropriate from a fundamental perspective.
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