Stock and bond volatility remained muted. US Economic news was mixed – jobs and pending home sales exceeded expectations, but home prices and durable goods orders fell short. Bernanke sent mixed messages in his testimony to congress, providing no hints of additional stimulus. Gold fell as a result. The ECB did a second round of major lending to banks, this time a staggering 529 billion Euros. The move garnered little media attention but initially appeared successful in creating demand for Spanish and Italian debt.
S&P 500: 1,368 (+0.2%)
MSCI EAFE: -0.7%
US 10 Year Treasury Yield: 1.98% (0.00%)
Gold: $1,712 (-3.4%)
USD/EUR: $1.320 (-1.9%)
- Monday – Standard and Poor’s declared Greece to be in “selective default”.
- Tuesday – Orders for durable goods in January dropped 4%, more than expected.
- Tuesday – US home prices in January dropped 4% compared to last year, more than expected.
- Wednesday – Bernanke affirmed interest rates are likely to stay low through late 2014, but offered no indication of additional monetary stimulus.
- Wednesday – The ECB provided 529 billion Euros in cheap three year loans to 800 participating banks.
- Thursday – ISDA ruled that the ECB arrangement to exchange Greek debt without taking losses will not trigger credit default swaps.
- Friday – German chancellor Merkel said this week’s ECB loan arrangement with banks would be the last similar type of cash injection.
- Friday – Online review site Yelp surges in its IPO.
- Friday – Spain raised its 2012 budget deficit target, prompting a rise in bond yields and a drop in the Euro.
The International Swaps and Derivatives Association (ISDA) ruled this week that the ECB’s mandated exchange for new bonds did not trigger default swaps. Fair enough. This is accurate because the move did not subordinate other debt and did not force anyone to take a lower value for their bonds. However, once private bond holders are forced into a collective agreement, ISDA should trigger the swaps.
The consequences of not doing so would be significant. The amount expected to actually change hands via swaps on a Greek credit default is “only” around $3 billion. The real issue is the perception of default insurance on the larger debt markets. Many debt owners use swaps as insurance. If they come to believe their swaps won’t be honored, many will be compelled to sell the underlying bonds. This would drive up interest rates and create a cycle which could easily throw Europe into bankruptcy.
Prominent figures such as former ECB president Jean-Claude Trichet have opposed paying the contracts for fear it will encourage betting against European debt. This is as short sighted as rules preventing short selling. We expect ISDA will do the right thing. Interestingly, ISDA is composed of 15 members – ten of whom are the very banks and dealers who write the swaps. While this seems like conflict of interest, it is probably better than if it were run by politicians.
An orderly Greek default, and the payment of outstanding credit default swaps, should mark an important milestone in what will be a very long road to economic stability in Greece and Europe as a whole.