Stress-testing of the euro currency performed this week came to a tidy end with an entourage of French ministers getting a free-trip to Berlin thrown into the bargain. For all of the bravado and apparent brinksmanship, Germany appears to have backed down in its demands for private investors holding Greek bonds to share financial burden of a financial restructuring. Instead Ms. Merkel claims that it would be sufficient to have debt holders volunteer to roll over maturing debt. The so called Vienna Initiative, which avoids railroading unwilling investors to defer repayment or shut up, might be just another attempt at kicking the can down the road until 2013 when the European Stability Plan kicks in.
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European bond markets – Nevertheless the yield curve rose in response to the appearance at a Berlin press conference involving Franco-German leaders. Chancellor Merkel said that a Vienna Initiative, used to assist Eastern European banks during the 2009 crisis, would be a “good basis” for lining up existing bond holders to voluntarily help Greece through its fiscal crisis. She also confirmed that any political resolution should also be worked out with the ECB so that there is no basis for ongoing dispute. We await the response of the central bank to today’s developments. Meanwhile Greek two-year yields approved the news and retreated from above 30% yesterday, while German yields rose at the 10-year by four basis points to match U.S. treasury yields at 2.95%.
Eurodollar futures – The kneejerk response to Friday’s Berlin press conference was clinical with investors selling the dollar and government bonds. However, the bond market reaction has calmed as investors recognize that on top of the danger of a sovereign default in Europe, there remains the sticky problem of global slowdown. Thursday’s pressure on short-dated Eurodollar futures reversed with three-tick gains at the first four contracts while deferred contracts fell by as much. September Treasury futures fell to 123-18 before rebounding somewhat to trade at 123-24.