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.

Read more from the author/contributor here.

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