ECB Seeks Protection
The euro got a strong boost from unconfirmed reports that the ECB is planning to swap its current holdings of Greek bonds for newly-issued bonds. Reports suggest that the new bonds will have the same features as the old ones, but we think this is very unlikely. Instead, we would not be surprised if it later emerges that the new bonds are to be governed by English law rather than Greek law. This would protect the ECB from the possibility of having to take forced losses if Greek law is changed to retrospectively fit collective action clauses into existing bond contracts. We note that this is a sign of progress towards an eventual Greek debt restructuring and so the euro’s initial reaction to the news was understandable. However, there are at least two euro-negative dimensions which will likely lead to euro weakness ahead once the full consequences are appreciated. First, if indeed this manoeuvre is intended to protect the ECB from forced losses, then the risk of a voluntary restructuring morphing into a coercive one has arguably increased significantly. If a coercive default does indeed eventually take place then a CDS event seems very likely with all the negative consequences for risk appetite that may bring. Secondly, as our rates strategists point out, if this ECB plan goes ahead it may appear that the ECB is receiving preferential treatment, raising questions about whether the ECB is senior to private sector bondholders − not only in the case of Greek debt, but also regarding the debt of other Eurozone nations that the ECB may be purchasing under the SMP. A private sector bond holder that has been suddenly and unexpectedly subordinated may have a reduced incentive to continue to hold on to that debt. EURUSD traded 1.2974-1.3159 and USDJPY 78.18-78.97.
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UBS Investment Bank