Monday Euro Group Yes, but March 1-2 Summit more Important

Currency in Crisis

The Euro group of European finance ministers will meet on Monday. There are to important decisions for it to make. First is whether to approve the private sector involvement initiative. The second is to decide to recommend the second aid package. However, many key issues will remain and it may not be until the heads of state summit March 1-2 before there is a greater understanding of what is really going to happen.

The euro's recovery in North America today reinforces the sense that the single currency remains range bound. The lower end of the range was frayed by the brief dip below the $1.2980-$1.3000 area. On the upside, $1.3150 may offer initial resistance now, with the $1.3200-50 offering a tougher ceiling.

There is talk, even at this late date, about modifying the PSI to generate greater savings for Greece. Yet this is probably a dead end. At this juncture the real issue is participation and whether there can be a greater inducement to participate rather than a punishment for refusal and still be regarded as voluntary (ie, not triggering CDS).

The Troika now projects the Greek debt/GDP ratio as 129% in 2020 rather than 120%, which was thought to be the litmus test on sustainability, though as we noted it is farcical when the Stability and Growth Pact calls for 60% and there is no theoretical grounds or apparently historical grounds to support such claim. Nevertheless, in for a penny in for a pound. If 120% is pulled out of the air, changing it to 129% should not require any greater suspension of belief.

The role of the ECB and national central banks is still not clear either. The ECB was thought to be willing to sell its Greek bond holdings at cost, to the Greek government, funded by the EFSF, thereby forgoing profits. However a German paper is reporting that the ECB may swap its bonds for new bonds from the Greek government at face value. This seems confused.

There would be no savings for Greece. It would not remove Greek bonds from the ECB's balance sheet. It would only help prevent the ECB from getting involved with the collective action clauses that might be retroactively inserted into government bond contracts.

The national central banks are different story, though the German paper suggests they too may swap their Greek bond holdings. Unlike the ECB which bought the Greek bonds for monetary policy purposes, the national central banks had purchased Greek bonds as an investment.

The German newspaper story notwithstanding, France appears to be leading a move to have the national central banks participate in the PSI, or in some other way, take partial loss on their Greek bond investments. Recall that the national central banks have revaluation account and the losses suffered on Greek bond holdings (thought to be around 15 bln euros) can be more than offset by the revaluation of other assets, like German and French bonds, and gold.

There is bound to be a fallout from how the central banks deal with their Greek bond holdings. For example, if the ECB forgoes profiting on Greek bonds, then other countries, like Ireland, will seek some modification from the ECB on promissory notes used to nationalize the banks. Irish officials have already indicated they are thinking along these lines. There may also be a rating impact on the countries whose sovereign bonds the ECB holds, depending on the resolution.

There is still the issue of an acceptable mechanism for monitoring the implementation of the accord in Greece. There may more discussion at Monday's Euro group meeting, but no resolution is likely.

Ahead of the March summit, the participation at the LTRO at the end of the month is significant. Some in Germany, Finland and the Netherlands appear to be feeling more confident about a hard default in Greece can be absorbed and the greater the liquidity cushion the more confident they may be.