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Sovereign debt: Europe might yet muddle through

Agreement on backstop financing for sovereigns might buy time for fiscal adjustment to forestall a rash of defaults.

It is just possible that the once unthinkable might happen in the European sovereign bond market in 2011: that it might somehow muddle through with no disasters and no defaults, Greece aside.

In January, markets were buzzing with rumours of mechanisms being constructed to allow Greece to reprofile its debt by buying it back in the secondary market to capture discounts to par of up to 30%, funding the purchase with new, longer-maturity bonds. This would of course require the participation, if not the lead sponsorship, of one large buyer based in Frankfurt. But whether or how it happens is already almost moot. The question is no longer Greece: it is everyone else.

Most market participants had begun the year braced for the imminent calamity of large investors abandoning peripheral eurozone bond markets on the basis that combined official government debt and implicit sovereign liability for bank debts simply looked unsustainable. Certainly some investors had stepped back in the final month of 2010; others had been prevented by their own risk managers or by their mandates from buying downgraded European debt. Government bond traders feared a prolonged buyers’ strike.

Four weeks do not make a trend.

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