PSI Driving Market Sentiment
Without doubt the on-going saga of Greece trying to reach an agreement with private creditors on a voluntary debt-haircut remains the major driver of market sentiment. As we finally appear to be reaching a favourable conclusion markets have seen a strong bid for risk assets and a significant amount of short-covering in the Euro resulting in a decent advance for the embattled currency.
If you can't keep up with the constant news flow, then following the BTP (Italian government bond) future will do just as well as it has proven to be a reliable barometer of how the PSI talks are going.
Needless to say, correlation in markets is once again very high, this time though from a positive perspective. Yesterdays rally was broad and deep with Portuguese 10 year bonds leading the way following an unsubstantiated rumour that the talks had reached a broad agreement; this move representing an incredible 10 % in value terms.
Right now it looks like investors will be taking a haircut of around 70%. Existing Greek bonds, as they mature will pay out 10-15% in cash and the new replacement 30yr bond will be issued with a coupon of circa. 3.5-3.75%. There has also been talk of a "GDP sweetener" for investors which would give holders a warrant to claim a higher coupon should Greece hit a predefined GDP target in future years. This is a novel & smart feature that has appeased the creditor group, but importantly does no further damage to Greek finances whilst the economy is struggling.
The current stumbling block has arrived out of left court. The IMF is suggesting that there should also be OSI (another new acronym to remember! Official sector involvement) in the haircut. Germany though is arguing against this. Let's hope the two sides are not too entrenched in their views. There is certainly room for compromise in this latest debate, as the ECB who holds €40bn of Greek bonds stands to make large gains from its holdings if they eventually redeem at par. The latest suggestion that the ECB give up future gains (but not participate in the initial haircut) seems a sensible compromise which would plug the current funding gap that appears to be concerning the IMF.
Should all this be agreed, which we considered to be the easier part, then markets will most likely take another move forward.
However, the trickier task will be the private creditor group trying to "sell the deal" to those not represented at the discussion table. There are still a number of unhappy holders of Greek debt out there, some of which have bought credit protection that will not be exercisable if the deal remains in its current "voluntary" state. There will be considerable pressure on this disgruntled group from the EU establishment, but one can imagine there remain challenges ahead before the whole situation is fully resolved.
Ultimately everything needs to be agreed and executed before March 20th, when the next Greek bond is due to mature. But with a lengthy legal process to follow there is realistically less than two weeks - we will of course keep you posted on material developments.