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Goldman Explains Why The Market Has Gotten Ahead Of Itself In Its European Optimism Again

Tyler Durden's picture




 

While hardly new to anyone who actually has been reading between the lines, and/or Zero Hedge, in the past few months, the Greek endspiel is here, and as a note by Goldman's Themistoklis Fiotakis overnight, the Greek timeline, or what little is left of it, "allows little room for error." Furthermore, "Due to the low NPV of the restructuring offer it is likely that part of this investor segment may be tempted to hold out (particularly owners of front-end bonds). How the holdouts are treated will be key. Paying them out in full would probably send a bullish signal to markets, yet it would be contradictory to prior policy statements about the desirability of high participation both in practical terms as well as in terms of signalling. On the other hand, forcing holdouts into the Greek PSI in an involuntary way would likely cause broad market volatility in the near term, but could be digested in the long run as long as it happens in a non-disruptive way (as we have written in the past, avoiding triggering CDS or giving the ECB’s holdings preferential treatment following an involuntary credit event could cause much deeper and longer-lived market damage)." Once again - nothing new, and merely proof that despite headlines from the IIF, the true news will come in 2-3 weeks when the exchange offer is formally closed, only for the world to find that 20-40% of bondholders have declined the deal and killed the transaction! But of course, by then the idiot market, which apparently has never opened a Restructuring 101 textbook will take the EURUSD to 1.5000, only for it to plunge to sub-parity after. More importantly, with Greek bonds set to define a 15 cent real cash recovery, one can see why absent the ECB's buying, Portugese bonds would be trading in their 30s: "Portugal will be crucial in determining the market’s view on the probability of default outside Greece... Given the significance of such a decision, markets will likely reflect concerns about the relevant risks ahead of time." Don't for a second assume Europe is fixed. The fun is only just beginning...

From Goldman Sachs - Market Uncertainty Ahead from Euro Area Sources

Overview

News reports over potential progress in Greece's PSI talks and the possible involvement of the ECB/EFSF in the restructuring deal have once again boosted the performance of risky assets, with S&P futures trading stronger and the dollar weaker. Peripheral Euro area bonds are trading flat-ish. Today is a quiet day in terms of data releases and markets are likely to start focusing on tomorrow’s ECB and BOE meetings.... In today’s note we discuss the reasons for managing our recommendations more cautiously, linked to Euro area sovereign uncertainties and the likely balance of risks around the ECB’s policy stance vs. market expectations.

A Tight Timeline For Greece Allows Little Room For Error

Greece remains an important source of risk to watch. As we have argued in the past, markets have interpreted the case of the Greek Private Sector Involvement as a precedent for restructuring within the Euro area. Over the last eight months of PSI discussions and preparations, the deterioration in Greek debt dynamics has been accompanied by a gradual deterioration in the terms of the deal for the existing bondholders (in an effort to achieve debt sustainability). In the end, the revealed preference of policymakers in the Greek case has been to pass a significant part of the cost of restructuring Greek debt to the private sector. Fundamentals in Greece may be much worse than in other countries, but the market has extrapolated the policymakers’ reaction function to the other peripheral countries with better fundamentals, thus pushing risk premia higher.

The next few weeks will be no exception. There are important issues to be resolved and further important precedents to be set thereby. To better grasp the complications at hand it is important to discuss the timeline of events ahead. The agreement between the Greek government and the creditors represented by the IIF is likely to be reached in parallel with an agreement between the IMF and the Greek government on the new austerity measures. Then the new austerity measures (including reductions in minimum wages and further reductions in pensions), which are likely to prove unpopular domestically, will need to be approved by the Greek parliament. All this needs to take place about 3-4 weeks ahead of the March 20th bond redemption, so that there is enough time for the IMF to sign off on the new loan package, for the offer to be extended across bondholders and for maximum participation to be pursued.

As we have discussed in previous pieces on the subject, outside official lenders, Greek bond holders and Euro-area banks, there are about EUR70bn of bonds scattered across different institutions. Due to the low NPV of the restructuring offer it is likely that part of this investor segment may be tempted to hold out (particularly owners of front-end bonds). How the holdouts are treated will be key. Paying them out in full would probably send a bullish signal to markets, yet it would be contradictory to prior policy statements about the desirability of high participation both in practical terms as well as in terms of signalling. On the other hand, forcing holdouts into the Greek PSI in an involuntary way would likely cause broad market volatility in the near term, but could be digested in the long run as long as it happens in a non-disruptive way (as we have written in the past, avoiding triggering CDS or giving the ECB’s holdings preferential treatment following an involuntary credit event could cause much deeper and longer-lived market damage). One way of staging such an involuntary restructuring operation for the holdouts would be the retroactive imposition of collective action clauses and their invocation following the conclusion of the voluntary restructuring operation. The introduction of such clauses would likely happen before the PSI exchange offer goes live – in order to further discourage investors from holding out.

The good news is that after a successful restructuring operation, Greece’s systemic importance as a source of risk declines meaningfully due to the limited refinancing needs, the meaningful reduction in debt servicing costs and the low levels of residual market exposure to Greek bonds post PSI.

Portugal’s Significance to Rise Post-Greece

Greece has created a market concern to do with low recovery rates in the event of a restructuring episode in the Euro area, which has been reflected across sovereign risk premia in peripheral Euro area bond markets. However, Portugal will be crucial in determining the market’s view on the probability of default outside Greece. This is because Euro area policymakers have gone out of their way to signal that Greece is a unique case, addressed with a one-off operation. Therefore it will be important that this commitment is maintained.

As Silvia Ardagna and Andrew Benito discussed in a recent Viewpoint, it is likely that Portugal may need an increase in assistance funds. The progress that Portugal has made in its adjustment programme and the reasonably limited resources that need to be put to work make it likely that a “top-up” of official funds to fully cover Portugal’s needs may ultimately be the preferred policy option.

But given the significance of such a decision, markets will likely reflect concerns about the relevant risks ahead of time.

 

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Wed, 02/08/2012 - 08:55 | 2137332 Robslob
Robslob's picture

Maybe "Gold Man" missed the entire rally expecting a QE3 drop and pop...

 

Fuck Goldman...what ever happened with Lloyd and the criminal defense attorney fiasco...?

Wed, 02/08/2012 - 09:11 | 2137372 French Frog
French Frog's picture

They must be Long BIIIIIG time

;-)

Wed, 02/08/2012 - 09:00 | 2137343 resurger
resurger's picture

 

So we buy more stocks ...

 

Wed, 02/08/2012 - 09:07 | 2137357 Jefferson
Jefferson's picture

I guess everybody but the technocrats have figured out that doing a cramdown on the private creditors while not allowing a trigger of Greek CDS is a really bad idea.

Wed, 02/08/2012 - 09:07 | 2137359 Chrikus van der...
Chrikus van der Rockhuizen's picture

i'm building a bunker and stockpiling it with baked beans

Wed, 02/08/2012 - 10:58 | 2137709 DeadFred
DeadFred's picture

Don't forget the Bean-O. Otherwise baked beans and bunkers are contra-indicated

Wed, 02/08/2012 - 09:09 | 2137362 dcb
dcb's picture

the market has top go to at least the top (or even perhaps a tad over) the top of the udn dwntrend line. sure it may go up more than that, but the algos are going to push it at least that high.

the market top was last week, now it's all bs hft crap where they can go for weeks bouncing off the second days lower low top a higher high like we saw much pf last spring until boom. when you see these changes in patterns of trading you know what's up  (this has happened a bit now)

Wed, 02/08/2012 - 09:16 | 2137382 distopiandreamboy
distopiandreamboy's picture

Apophenia: the experience of seeing meaningful patterns or connections in random or meaningless data.

Wed, 02/08/2012 - 11:09 | 2137748 DeadFred
DeadFred's picture

On a long enough time line the survival rate for every fiat currency drops to zero.

The anticipation of the expected event and the impatience for it to arrive. At least it isn't as bad as the emotions that surged through some big time forex traders heart when he just heard Tyler say "But of course, by then the idiot market, which apparently has never opened a Restructuring 101 textbook will take the EURUSD to 1.5000, only for it to plunge to sub-parity after" Why would he need porn when he can read that?

Wed, 02/08/2012 - 09:27 | 2137406 I should be working
I should be working's picture

So the contra-Goldman trade would be to buy?

Brilliant deduction, Europe isn't fixed yet.  Who knew?

Wed, 02/08/2012 - 09:50 | 2137470 lizzy36
lizzy36's picture

Everything is fixed.

Bernanke is world Czar and he has your back.

The music is blaring and everyone is dancing as fast as they can. 

Churn baby Churn.....disco inferno.

Wed, 02/08/2012 - 10:38 | 2137646 vote_libertaria...
vote_libertarian_party's picture

Damn, this is messing with my double secret decoder ring reading.  If Goldman says sell it must be time to buy???

Mon, 02/13/2012 - 01:18 | 2152616 q5251355
q5251355's picture

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