Grexit is unlikely, but expect six months of Eurozone volatility.
Financial markets took the result of the Greek general election largely in their stride yesterday. The victory of hard-left, anti-austerity party Syriza was predominantly in line with analysts’ predictions, with plenty of advance warning for investors and traders.
But even so, the news did initially wobble markets, with the euro careering to $1.1098 – an 11-year low (see graph) – before rebounding. The yield on the 30-year Treasury bond in the US also hit a record low in early trading, as investors shifted funds to supposedly safer assets.
So with the prospect of a drawn out battle between Greece and its creditors over Syriza leader Alexis Tsipras’s demand for a substantial Greek debt haircut, and the prospect of Grexit, what should traders brace themselves for in the coming months?
The change in the Greek political landscape comes at a time when global markets already face significant pressures. Crude oil prices are still falling this year (having lost around 50 per cent in 2014), and last week saw the European Central Bank (ECB) unveil a QE programme that’ll see it buy €60bn (£45bn) worth of bonds each month.
However, even though Greece will not necessarily be part of Eurozone QE, it could be a saving grace for markets. “It’s just as well the cavalry (in the form of Mario Draghi’s aggressive QE) came charging over the hill to nullify the strong performance put up by Syriza,” says Panmure Gordon’s David Buik. QE has underwritten European equities: the Euro Stoxx 50 index, a barometer of Eurozone blue chips, closed up 0.94 per cent (see graph) yesterday. “We could [also] see continued upside in the German Dax on the back of a weaker euro, which will occur organically owing to the aggressive liquidity move from Draghi,” says IG’s Brenda Kelly. CityIndex’s Ashraf Laidi adds that “going long on the Dax remains the preferred equity path”. The index has hit new record highs over the last three weeks, and will continue to benefit from the German economy doing better than the rest of the currency bloc.
The German bund, along with precious metals, may see capital flows from intensifying stress levels, Kelly adds, with gold already having benefited from the prospect of QE. The fallout from the election is unlikely to turn into a systemic crisis, but safe haven plays will most likely prove popular.
And many analysts believe that QE will also limit existential anxiety in the Eurozone, soothing market fears of a Greek exit. The injection should help raise inflation levels in the region, boost economic momentum and lower the exposure of periphery bond markets to rising levels of volatility, explains Maria Paola Toschi, global market strategist at JP Morgan Asset Management.
But despite hefty fears that other member states would consider (or be forced into) an exit should Greece leave the Eurozone, many think it is a limited risk. Paras Anand of Fidelity Worldwide Investment says the uniqueness of Greece’s economic situation and the tightening of yields across the region make it unlikely. The yield on Greek 10-year sovereign bonds hit 8.89 per cent yesterday – the highest in the bloc, but failing to test the 10.68 per cent seen earlier in the month – “another signal of the relatively lower levels of market stress,” says Toschi. And crucially, she adds, “the yields on other peripheral government bonds fell, and are not showing signs of contagion as they did in 2012.”
But while the raft of measures rolled out by the ECB and other European institutions, designed to quell systemic risk in the single currency bloc, should mean member states feel somewhat reassured in the event of Grexit, “they would do little for Greece itself,” says Toschi. The Athens Equity Index has already fallen by 28 per cent since 30 September 2014, with the low point reached in early January.
This isn’t to say that there aren’t still significant risks to the fragile currency union. Southern Europe will “feel some of the pain over the coming months,” says Kelly, with Italy’s Mib and Spain’s Ibex “likely to see declines as volatility becomes a factor”.
FxPro’s Angus Campbell points out that the broader picture is what the bailout negotiations bring – “this is where volatility will materialise from.” It’s “probably best,” he says, to “steer clear of Greek stocks, and if negotiations gradually lead to a heightened chance of Grexit, it’s best to de-risk portfolios and sell the euro.” The impending milestone is 28 February, when the existing bailout ends and will have to be extended. A Greek exit could see the country default on €256bn of debt – a “huge risk” for the euro area, Deloitte’s chief economist in the UK, Ian Stewart, said yesterday. Toschi adds that Greece leaving the EU “and any default on its outstanding debt, could severely damage the EU’s credibility, shaking the foundations of the treaties that bind its members together”.
The best solution for markets and for Europe, says Toschi, will be a speedy negotiation between the Troika and the new government. It could be some weeks before Greece has to confront its creditors, but Stewart thinks a compromise is likely: “Greek secession is the last thing the euro area needs as it grapples with deflation and low growth.” Moreover, Syriza’s failure to win an outright majority increases the chances of dialogue between the two sides, adds Laidi: “and while another deadline debt extension isn’t the most economically viable solution for the five-year old problem, it remains the most preferred means of stabilising increasingly frequent surges of volatility.”
But there’s little doubt that there are turbulent times ahead. “When trading markets, there are a huge number of imponderables to digest,” says Buik. “Expect a high degree of volatility in the week to come. I suggest trading these markets very selectively” as the news rolls in.