Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Wednesday, 29 February 2012

Eurozone Snap Comment - 29-Feb-12

The extra day of the leap year was fully exploited by ECB to further engage in monetary debauchery. First a gargantuan sum of 530bn was loaned out to 800 banks in exchange for collateral which the banks themselves wouldn't lend against. Then the SMP was activated to buy Portuguese bonds. It is the latter which is of interest since the former has been commented upon ad nauseum.

After two weeks the SMP was reactivated presumably to counter the slump in PGBs (Portuguese Government Bonds). The interesting part is that they bought 10 year bonds as opposed to shorter maturity (2-4 years) that they have been buying. This does not augur well for Portuguese debt holders. In any case, the precedent set by Greece means that ECB is a senior creditor. Therefore any additional bond buying increases the losses that ordinary bondholders must suffer in the event of a restructuring (voluntary or not). Moreover, buying long-dated (10 year) bonds strongly indicates that a Portuguese haircut is imminent despite claims of Greece being a special case. Again going back to the Greek precedent, ECB knows that it will have to fork over any profit from bond buying in case of restructuring. In other words, debt equivalent to the difference between par and market price is written off. Therefore it makes eminent sense to buy bonds which are trading at the lowest price adjusted for duration risk. Looking at PGB cash prices across the curve, ECB's behaviour starts making sense.
Price (approx.)
Debt relief
PGB Jun-14
PGB Feb-16
PGB Apr-21
PGB Oct-23

Does this mean that Greece is not a "special case" but just the "first case"?

Associated reading:
The current Portuguese debt waterfall is here and my argument on why Portugal is likely to follow Greece was made here.

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