Greece: The Midnight Hour

Takeaways:  Efforts to limit direct exposure means Greece is increasingly morphing into a political, rather than a financial crisis; but that can quickly change if companies and markets freeze or the political crisis extends elsewhere. The ECB’s move today to extend QE asset eligibility was necessary in any case…and possibly pre-emptive.

Into (more) uncharted waters…

Where are we now? Approaching midnight or well past? Who knows? These are uncharted waters since Greece’s last-minute overtures to international creditors on Tuesday were not enough to save it from becoming the first developed economy to miss a payment to the International Monetary Fund (IMF) – thus putting Greece on a par with Zimbabwe, Sudan and Somalia.

Developed countries just don’t ‘default’ to the IMF. In fact, non-one ‘defaults’, countries remain in ‘arrears’; since the IMF doesn’t restructure and doesn’t forget. As the lender of last resort, the IMF gets paid first. Thus the agency’s initial intervention in Greece was highly unusual and this missed payment leaves both sides in difficult positions.  IMF spokesman Gerry Rice said Greece can now only receive further funding once the arrears are cleared….but the IMF is the agency Greece would normally turn should all other avenues close in a  ‘true’ default.

It’s a paradox that the Greek government hopes it will never have to resolve.

And in the markets…

Still, the incident passed almost without incident in many markets. In fact, when the referendum was announced over the weekend markets reacted negatively and dropped quickly in Monday’s opening sessions. However, when Greece finally missed its IMF payment and the bailout expired, equity markets rose. Go figure!  The fact that European nations didn’t enforce their cross-default clauses helped. And, of course Greece is but a small cog in Europe’s wheel, direct financial contagion is now pretty limited and thus in Europe’s dual narrative of recovery and peril, the recovery strand can dominate.

Then again – as Lehman proved – ‘contagion’ can be a many-headed and unpredictable foe. As Mr Carney pointed out, UK direct exposure to Greece is small, but there is significant potential for financial paralysis in a drawn out process or sharper crisis.

But, perhaps – in these topsy-turvy times – this is what markets are banking on: not the paralysis, but the pre-emptive ECB vaccination.  Indeed, they may have been given more hope today, as the ECB announced that some quasi-corporate assets would now be eligible for purchase under its QE programme. The ECB was already struggling with a shortage of suitable assets to buy in sovereign bonds. This, as we’ve discussed previously, at contributed significantly to yields turning negative this spring. According to the FT the updated list of eligible assets on the ECB’s web site now includes those from Italian infrastructure and other state-owned firms to the list. The ECB also leaves the way open for further amendments, saying the “list may further be amended on the basis of monetary-policy considerations and duly reflecting risk-management issues”.

Perhaps a debate for another day as to when (if ever) central banks will ever revert to their pre-crisis roles. For now, the yield curve is in scope and this may be part of a broader plan to lower lending costs for infrastructure borrowers. This would make sense if this was followed by a rational burst of economic and political activity to invest in the asset class, kick start demand and improve long term competitiveness. Maybe tying into Juncker’s investment plan? Certainly, the ECB will also be mindful of the potential for financial market paralysis and this should lower lending costs along the curve and may-be kick start activity again – depending on the next Greek move.

Debt markets have been more watchful since Greek rhetoric began to escalate and volatility increased. On Thursday, Danaher issued a €2.7bn bond, breaking what has felt like a remarkably quiet period after a rush of activity when Eurobonds were the market du jour. Monday’s spikes in credit-default swap spreads might have been short-lived, but it provided a warning short across the bow of complacency.  The ECB will intervene if the crisis escalates – it’s surely just a case of how and how much.

But what is ‘escalation’ from here – or is still a chance of a deal? It might be that markets are sanguine on recovery – and deal hopes – although you have to ask “what deal?”.  Trust between Athens and European capitals is at a nadir. Creditors don’t want to talk about a new deal until after a referendum on the old one – a vote that is too close to call.  Whichever way the way Sunday’s poll goes, all sides need to return to the table,  but there is no clear roadmap for either outcome. The next big date in the diary after this Sunday is Greece’s key payment to the European Central Bank (ECB) on 20th July – which may well remain significant. In the event that Greece misses this payment, it’s unclear what ECB will be able to do to support Greek banks – unless it changes its own rules.

Thus, ultimately, this is now a political crisis. It’s not the market, but the will of the 18 other Eurozone governments that decides Greece’s fate. It’s a highly charged dynamic that raises all kinds of awkward questions about sovereignty, democracy and the nature of the European project  – which will certainly spill over into the BREXIT debate.  Another question for another day.