Markets struggle to come to terms with potential Greek Euro exit
18 May 2012
No prizes for guessing the single story that has preoccupied investors this week. The collective failure of Greek politicians to form a coalition government has left markets desperately trying to put a price on the likelihood of a Greek exit from the Eurozone. The fear of contagion that such an event could provoke (not only from financial institutions holding Greek debt, but also from a possible en masse exodus from other peripheral Eurozone nations) has prompted a flight to safety from investors away from equities and into safe haven assets.
Despite all the scenario-planning being done by governments, central banks and investment banks, the full implications of a Greek exit are still far from clear. Without anything tangible to cling on to, the headlines at the moment appear very grim, and perhaps rightly so. Whatever happens in Greece, we know the European Central Bank is ready and willing to act, but that the trigger-point has not been reached yet.
One of the key fears at the moment is a possible run on the European retail banks. Two dangers arise from such a scenario: the first would be individual banks running out of capital and requiring state intervention; the second is a substantial outflow of capital from Europe. The former scenario can be contained; the latter is more problematic.
Greek banks lost €700m in withdrawals on Monday alone, as Greek citizens took the opportunity to move ahead of any likely capital control regulation if Greece was preparing to revert to the Drachma. The important statistic here is where that capital has gone. If savers are retaining the Euro through a move to German banks the problem is likely to stay contained. If, however, the move is from Euros to US Dollars, that is another matter. For now though, it seems the retail saver is still backing the Euro.
On Thursday markets reacted strongly to reports that Bankia’s customers had withdrawn more than €1bn since it was part-nationalised by the Spanish government last week. Spain’s economic secretary had to deny the reports, but by this point Bankia shares had already fallen by more than 25%. Adding to the collective woes on Thursday was the news that credit ratings agency Moody’s was downgrading 21 Spanish banks.
Despite the prevailing negative sentiment, it’s worth remembering that a Greek exit from the Euro is not yet a fait accompli. The rejection of austerity by the Greek electorate was clear, yet opinion polls suggest that some 80 percent of Greeks wish to remain in the Euro. It seems they can’t have it both ways so the next election to be held on 17 June will be fought on a single defining issue, stay in or get out. Many appear to expect Greece to exit but one cannot fully discount a change of heart.
In amongst the maelstrom, Germany continues to benefit from the weakness of its neighbours. Understandably this continues to be a major irritant to the other European Union members and a source of frustration further afield. Today there have been suggestions that President Obama will use the G8 summit at Camp David to push hard for Germany to soften its stance on fiscal austerity and seek out more growth-oriented solutions similar to those adopted by the US. With Chancellor Angela Merkel looking increasingly isolated and Europe looking increasingly desperate, there is clearly some room for concession at the negotiating table. Noises from the Bundesbank suggest a potential softening on its stance around inflation, which will provide hope to those countries looking for breathing space. It will also be good news for new French President Francois Hollande, who will be expected to capitalise on the opportunity to push through some more pro-growth measures. They need to get to the table first though.
The fact that the market is struggling to price in a huge array of possibilities creates volatility and opportunity. For our portfolios we are reducing our defensive position a little. The dash into safe havens has given us the opportunity to sell down some of our treasuries and gilts exposure into rising prices. We’re also looking to return to risk assets in phases, at certain levels, buying on the dips and profiting from the uncertainty.
Although a lot of bad news has already been priced-in to asset values a full blown, disorderly Greek exit likely has not. Markets could still go either way, and until some tangible evidence emerges to support one case over the other it remains sensible to be neutral but exploit opportunities arising from the ongoing volatility through shorter term trading.