By Brian Dolan, Head Market Strategist Topic Suggested by: James He, Brand Ambassador, McMaster University
Is This the End of the Line for Greece?
After negotiations with its creditors hit a seemingly impenetrable wall, the Greek government over the weekend imposed capital controls and shut down the nation’s banks for at least a week. The Athens Stock Exchange also announced it was closing while banks remain shuttered. Greeks cannot send money out of the country, and can only withdraw EUR 60 per day, among other capital restrictions. The government called for a national referendum on July 5 for voters to vote ‘yes’ or ‘no’ on whether to accept the terms dictated by Greece’s creditors (the European Central Bank (ECB), the International Monetary Fund (IMF) and the European Union (EU)).
A ‘yes’ vote would mean voters approving a continuation of the austerity measures Greece has been forced to adopt and open the door to additional bailout funds. A ‘no’ vote would set the stage for ‘Grexit’—Greece defaults on its debt and is forced out of the Euro single currency. While a ‘yes’ vote would likely avert a financial catastrophe, it would also doom the Greek economy and its people to even more severe hardship in the years ahead, with no real end in sight.
A ‘no’ vote would likely trigger financial chaos certainly in Greece, and potentially in other highly stressed Eurozone countries, like Portugal, Spain and Italy. There is also the potential for a wider contagion negatively affecting global markets as investors flee the uncertainty emanating from Europe and seek the safety of non-European government bonds, such as US Treasuries or Japanese government bonds.
The outcome of the referendum is difficult to assess. In recent polls, Greeks have expressed a strong desire to keep the Euro and stay in the Eurozone. At the same time, they overwhelmingly voted for the current government based on its anti-austerity platform. The harsh terms of the aid package they are voting on is also to many an insult to Greek pride and independence. I’m inclined to think a ‘yes’ vote will prevail, and that will give the government room to maneuver and return to the negotiating table.
Time is Short
Greece will in all likelihood miss a scheduled EUR 1.5 bio re-payment due to the IMF on June 30. If it fails to pay, it will be cut-off from any further financial aid from the IMF, potentially accelerating the spiral toward Grexit. Assuming a ‘yes’ vote is delivered, the Eurogroup of lenders (ECB & EU) could then develop a third aid package, allowing Greece to honor its commitment to the IMF and restore additional funding from them as well. Greece also has a EUR 3.5 billion bond payment due to the ECB on July 20. Even with a ‘yes’ vote, the timing is extremely tight; everything would need to go quickly and smoothly for aid to be disbursed and payments made.
That leaves a very tense week ahead for investors and markets. Market liquidity is also likely to become an issue as we head into the US Independence Day long weekend. (Friday is a US market holiday.)
What does Greece Mean for Investors?
Up until this weekend when Greek/EU talks broke down, global markets had been reacting relatively calmly to Greek drama, likely on the basis of expectations that a deal would eventually be reached. Now that a Grexit is viewed as more likely by many (and a done deal to some), markets have begun to show signs of strain. That Chinese markets were also dropping sharply before this weekend is yet another major negative for global investor sentiment.
All in all, the fallout has been relatively contained so far, and is not nearly as severe as the 2011/12 setback when the Greek debt crisis first boiled over (e.g. Greek 10-yr yields were at 25/30% vs. 14.5% now). Still, there is no way of knowing how much further risk assets may fall in the days ahead, and there is always the possibility that market declines turn into their own vicious cycle as investors panic and head for the exits en masse.
The EUR/USD exchange rate should serve as a good barometer of the seriousness of any market panic. On Monday following the weekend breakdown in talks, EUR/USD gapped lower to open the trading day, but recovered to close above Friday’s high. Keep an eye on sustained weakness below 1.0950/60 (bottom of the daily Ichimoku Cloud), and again if below 1.0820 (lowest since the end of May).
My initial expectation is that markets will take a Grexit in stride and not react too severely to the downside. I would favor using further weakness as an opportunity to put idle cash to work, buying stocks incrementally on further dips. If there is a sharper breakdown, I’d be prepared to wait for some signs of stabilization before resuming a scaled-in buying approach. In the end, Greece is a tiny economy and its fate should not significantly alter the global economic outlook. A Grexit would be a travesty for the Greek people and a major black eye for European unity, but the economic impact should be quite minor. With that in mind, once the dust settles and markets realize a Greek default and Grexit is not the end of the world, I would look for major markets to rebound quickly. On the more positive side, if a Grexit is avoided and a positive resolution is achieved, I would also expect risk markets to rebound sharply.