GREECE: AFTER THE REFERENDUM
New elements to consider:
- The Greek referendum held on Sunday led to a large NO victory (61%). The strength of this response is a clear signal to bolster Tsipras’ legitimacy and increase the leverage of the Greek government in its ongoing negotiations with Brussels.
- The current Greek economic and financial situation is unsustainable. Time is lacking for the Greek government to find an outcome, as the pressure from the domestic situation is becoming unbearable. Also, keep in mind that July 20 is an important deadline, with Greece due to redeem EUR 3.5 bn to the ECB.
- Greek finance minister Varoufakis announced his resignation on Monday morning despite the NO victory. Is this a sign of goodwill on the part of the Greek government and the Europeans ahead of forthcoming negotiations, given the strong defiance that European creditors have shown toward his atypical personality? Probably, but it is not a great sign in democratic terms…
- The majority of involved parties seem open to negotiations, as illustrated by Tsipras’ speech on Sunday night. An EU summit is planned on Tuesday and Angela Merkel is meeting François Hollande this Monday evening in Paris.
- The ECB is currently holding a meeting to reassess its emergency liquidity mechanism (ELA). We expect a status quo (keeping ELA at current level) until chances of a deal can be better gauged.
- Last Friday, the IMF published a draft on the sustainability of Greek debt, arguing for a restructuration.
Options are waning:
As discussions between Greece and its creditors resume, and in line with our previous message, we now see three potential outcomes:
- A rapid deal on terms close to the latest package proposed by Tsipras, thus including a debt renegotiation component (rescheduling or haircuts). The most likely scenario (50% probability) would be that Tsipras reiterates his latest offer, which is acceptable in spite of its debt restructuring component. A “happy ending” could still prevail, since the details of the deal are already known and could be signed quickly (possibly as early as this week). Notwithstanding some short-term volatility, expectations of a rapid deal should eventually calm markets. With our baseline fundamental scenario unchanged, our current asset allocation overweighting European equities remains appropriate, as we would expect these markets to rebound and reach our year-end targets.
A laborious deal
We initially believed that a renewed tough negotiation process would result from Tsipras requesting an even better deal than the one he put forward last week. However, the real risk today of a laborious path to a deal comes rather from the possibility that European parliaments reject rather than ratify any new proposal (30% probability). Bridge financing would also need to be found. In such circumstances, we would expect European equity markets to suffer strong volatility over the coming month, as political turmoil continues to make headlines. New lows for the year may be experienced. Over time though, with investors getting accustomed to the situation and a deal eventually signed, losses might remain relatively contained.
NO deal, disorderly Grexit
Finally, the worst outcome following this NO victory would be a failure to reach an agreement despite weeks of negotiations, leading to an unprecedented and disorderly exit. Under this extreme scenario (20% probability), a Grexit would have medium-term impacts on financial markets, as it would create a dangerous precedent. Although the ECB has tools to respond to short-term disruptions in bond markets, spreads would need to reincorporate the conversion premium that had gradually disappeared in recent years. Foreign investors would demand a higher risk premium to hold European assets, triggering outflows. Our bond positioning might also be affected in the event of a Grexit, especially in the most illiquid segments (credit). A redefinition of our baseline scenario, in terms of expected returns, would be necessary to take into account this political risk premium.
Open questions for the future:
- If a deal is ultimately reached, will it be a good one? Some debt restructuring is justified but implementation issues are numerous. How will Europeans react to what would de facto be the first fiscal transfer of the Eurozone’s short history?
- What about the European construction process? Will the Greek episode mark the end of the European construction and integration process? Or is it necessary turmoil on the path toward acceptance of more institutionalised fiscal transfers, even though limited and framed (the missing link to move closer to an optimal currency zone)? Should the Eurozone shy further away from even partial fiscal integration, it would remain an incomplete achievement, with institutions too fragile in the medium term to reassuringly deal with a period of renewed economic and financial stress.
We continue to monitor the situation closely and will wait to hear more from the ECB meeting, the Merkel/Hollande meeting and the EU summit. To be continued…