Takeways: At pixel time….Greece is offering an olive branch (of sorts) and markets are up. That said, investors didn’t seem perturbed by the breakdown of Monday’s talks. This isn’t 2011. The Eurozone economy is growing, banks are stronger, markets are flush with liquidity, backstops are in place and Greece’s debt is mainly ‘official’. With the right deal, the Eurozone (or parts thereof) could, conceivably, kick on to become the turnaround story of the decade….may-be…The argument against such sangfroid are that this particular olive branch (previously rejected) would just reset the countdown; the Eurozone still appears to have trouble ‘baked in’ and unwavering central bank support is intensifying riskier market behaviour. Greece’s travails shouldn’t topple the Eurozone and there is significant potential for growth; but GREXIT or not, European opportunities need careful picking.
We‘ve had this date with each other from the beginning…
Some macroeconomic indicators might be starting to turn in their favour, however, since the first bailout, Greece’s debts looked beyond the salvation of austerity alone. No doubt a deep level of structural change was required, but in the midst of global economic recovery, it never seemed quite enough. On Monday, the two sides failed again to reach a compromise on the balance of reform and debt restructuring and each expressed their determination to take this to the wire…
However, as we go to ‘press’, Greece appears to be offering an olive branch – albeit a recycled one lacking in leafy detail. They’ve agreed to revisit the ‘compromise’ proposal devised by the EC’s Pierre Moscovici. This would extend the current €172bn programme by six months, during which time Greece continues to post a surplus, but with discretion over which economic reforms it follows. It now looks as if Greece’s new application will be ready for review tomorrow morning, with this Friday set as the new deadline. This is so the deal can be passed through relevant parliaments before the bailout expires on the 28th.
Greece has also published the proposals that Yanis Varoufakis took to the previous eurogroup meetings – just to up the ante a little more. However, looking at these, it’s obvious why the eurogroup dug in their heels – a shortage of numbers. To steal a line, they’re bringing a Word document to an Excel fight. The ‘Moscovici compromise’ was effectively rejected by the Eurogroup previously on this basis. The devil remains in the detail – where there are still significant differences. The name could also be a non-trivial issue – ‘bailout’ with ‘extension’ sounds like 1-0 to Berlin, ‘loan’ with ‘bridge’ would look like victory for Athens.
Since Greece has no budget deficit, the biggest problems here are bank funding and refinancing. On 28 February the bailout program expires and with it access to the ECB’s ELA banking backstop. The ECB could decide to close this line sooner – or extend it – depending on the likelihood of a deal. However, if, as is possible, Greece won’t have the readies to satisfy IMF loans due in early March, this issue could become moot. If Greece defaults to the IMF, it could make its collateral inadmissible to ELA. The next bond date is in June, but it seems unlikely that the ECB would extend ELA access that far without a firm deal.
The closer we get to the 28th with no deal, the more likely it is that Greece will need capital controls. Bank withdrawals are picking up again. Alternative funding options are severely limited. It will be tough to issue any kind of private debt, since Greek banks won’t be able to buy and external investors will be highly reluctant. There is clichéd talk of Russian and Chinese money – like they don’t have their own issues. The most likely option – even beyond Friday – is still an agreement within the Eurozone, partly because much like the Eagles’ Hotel California, you can check out, but no-one really knows how you leave. This leaves plenty of cooling-off time to acquiesce under the old deal – if the situation in Greece gets too dire, or for a new third bailout deal to be thrashed out with the benefit of a clean sheet.
This being the Eurozone, it’s also tough to rule out some kind of deus ex machina plot devise to resolve this at the 11th or 13th hour. If Dallas can bring Bobby back from the dead, the Eurozone can do the same for Greece.
Deal or no deal….no catastrophe
The relative calm in the face of such uncertainty shows just how much has changed in four years. Greece was always a small cog in the Eurozone wheel at c.2% of GDP, but in 2011 the weakness of other cogs and lack of fail-safes vastly inflated the impact of failure. Today, Greek debt is largely owed to the IMF/ECB rather than the private sector, the Eurozone is set to grow at its strongest rate since 2010, and the region’s banks are significantly stronger – assuredly so having gone through the discipline of the Asset Quality Review. Plus, we obviously have the all-important commitments from the ECB, from the massive and general support of QE to the promise to buy the debt of struggling sovereigns. This adds up to far greater resilience and better backstops than 2011, should the worst happen – plus, crucially, great potential for rebound if a deal is done.
Balanced against this is the fact that Greece could remain a lingering uncertainty under an ‘extension’ deal. Germany and Spain are picking up, but the region isn’t entirely a picture of health. France and Italy, the zone’s second and third-largest economies, stagnated at the end of 2014, as did Finland. Cheap oil is only a boost if consumers and companies feel confident enough to spend. Structural imbalances remain. A short spell of mild deflation might be helpful, but there’s growing risk of entrenchment across Europe as a whole, with central bank action having little effect. Swedish inflation stayed negative for sixth month in a row in January, despite its Sweden’s Riksbank moving its benchmark rate below zero for the first time in its history. The ECB QE programme is there for a reason.
If there is no deal, the risk of contagion still lurks, albeit not to the same extent or the same places as 2011. Peripheral Europe looks stronger economically – but more fractured politically, whilst risks have also been building elsewhere. A further rapid loosening of global monetary policies has intensified the pull along the yield curve. Last month more than $3tn of European and Japanese debt in traded with negative yield. Investors seeking returns have found plenty to sink their teeth into. Emerging market companies issued US$2tn in ‘hard currency’ bonds in 2014, compared with US$107bn in 1994. High-yield bonds were issued in record numbers in Europe last year and issuance to date in 2015 is running at double the 2014 rate. However, conditions in secondary markets are markedly tighter, as regulatory and other changes have limited the appetite of investment banks. The October flash crash demonstrated the potential for amplified volatility if investors rush for the exit. Reckoning could be swift.- although, the question of where investors would put their cash in this low-yield world may limit the pain.
These are reasons to be cautious in general, but that doesn’t exclude the potential of specific, well-chosen opportunities in Europe. Improved growth, primary market liquidity, significant backstops, stronger banks and cheap oil – these could be solid mitigating factors or indeed strong growth drivers, if peril remains mild or dissipates. Sterling has hit a seven year high against the euro this morning and asset prices remain low. This creates opportunities for growth and acquisition and we expect buyers to focus on high-quality, geographically diversified assets in Northern Europe – particularly in industrials, life sciences, consumer products, tech, telecom and media.