Market Insights: Greece – from stalemate into uncharted watersContributors Dr. David Stubbs, Global Markets Insights Strategy Team
The announcement late on Friday night of a Greek referendum scheduled for 5 July capped days of futile negotiations, sparked a weekend of dramatic moves and set up a week of confusion, default and yet more Greek drama. In a blunt response to the referendum announcement, the Eurogroup of finance ministers insisted that no extension of the Greek bailout programme would be forthcoming and that it would cease to exist on 30 June, as scheduled. This sets up the bizarre situation of the Greek people being asked to vote on a proposed package that is no longer on offer.
The European Central Bank (ECB) also swung into action, announcing that liquidity assistance available to the Greek banks would be frozen at the current level. With significant amounts of cash having been withdrawn from the few ATMs working on Saturday, the Greek government announced on Sunday afternoon that it was a declaring a bank holiday not just for Monday, but the whole week. Depositors can withdraw funds from ATMs, but only up to a limit of EUR 60 a day. Greece will almost certainly default on the International Monetary Fund (IMF) on Tuesday and watch its bailout programme and the offer from its creditors fizzle away. After that, the country and the eurozone will truly step into the unknown.
A default on the IMF does not guarantee Grexit; if the Greek people vote in favour of a deal on 5 July, we think it's still more likely than not that Greece will remain in the euro. But the probability of an exit from the single currency - accidental or otherwise - is now higher than it was. It will important to see whether the ECB reacts to a Greek default on IMF loans. If it tightens the criteria for collateral submitted for the Emergency Liquidity Assistance programme, then Greece will potentially have to use IOUs to pay key bills within the country, including public sector salaries when they fall due at the end of the month. Those IOUs could start trading as parallel currency long before a final exit from the euro. But we should remember that there is currently no legal procedure at all for leaving the eurozone. If this outcome were to occur, it seems to be many weeks away, and we are assured of many more twists and turns in the story before then.
Market moves this week will likely be marked by contagion and risk aversion, although no one knows to what extent in a world in which Greece remains firmly within the euro. A weaker euro, higher peripheral bond yields and lower peripheral equity markets (especially banks) will probably be matched by strength in safe haven assets such as German Bunds and British Gilts, as well as sterling and the Swiss franc.
We suspect the moves with be much less violent than in 2011 and 2012. Europe is more able to take the fallout from Greek turbulence, with stronger economies, healthier banking sectors, smaller fiscal deficits and greatly reduced linkages to Greece itself. Furthermore, the region has tools that were not in place the last time round, most notably the ECB's quantitative easing programme. In addition, the Outright Monetary Transactions (OMT) facility could be used to support eurozone sovereign bond markets, the legality of such a move having recently been affirmed by the European Court of Justice. Use of the OMT does require the country in question to ask for help and to be in a bailout programme, hence the hurdle for such action remains high. But whatever the mix of tools employed, the ECB has already said it will act if needed to preserve growth and control inflation expectations.
Politics was always going to cause volatility in European assets this year. The big picture remains one of economic recovery and aggressive policy action that should support corporate earnings. Both the equity and debt of quality European companies should perform well in this environment and reward investors who stay invested. If risk assets do decline significantly over coming days, we would tend to regard that as a buying opportunity.
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