AXA’s Iggo on Greek referendum: “Ne” vs “Oxi”

Chris Iggo, CIO Fixed Income at AXA IM comments on the possible impact of the Greek referendum

Markets have been consumed by the Greek tragedy for weeks. It reaches some kind of climax this weekend. Symbolically the referendum could be seen as a vote for membership of the euro, or a vote for or against austerity, or a vote of confidence in the government of Alexis Tsipras. It is not going to be an anti-climax, but it is not the end of the Greek story either. Even if the mandate is to accept the conditions of a new bailout package and keep Greece in the euro, there is much work to do in terms of implementation and restoring some semblance of economic stability to Greece. The bigger challenge is to make sure, with or without Greece, that all the work done in recent years to make the euro financial system stronger is not all going to fall apart like an over-filled pitta. Q2’s increased bond market volatility doesn’t look like it’s going away anytime soon.

“Ne” or “Oxi”
I don’t think I’ve ever known so many acquaintances that have decided to take their vacation in Greece. One colleague is there at the moment, another is due to travel this weekend, as are friends of mine. I am also scheduled to go to Zante in August. The word from our man on the ground is that there is relative calm – although this view comes from the luxury of a 5-star all-inclusive resort with descriptions of local conditions largely based on conversations with the cocktail waiter and the golf caddy. All reports seems to be that tourists are being welcomed as normal and that there is little disruption to the “sun, sand and sailing” ritual of a Greek holiday. Of course, the “business as usual” nature of the tourist economy might not reflect the underlying reality of Greece being in real trouble if this weekend’s referendum on last weekend’s offer from the institutions (subsequently withdrawn) results in a “No” vote. I’m trying not to think what the consequences might be for my summer vacation, and at the same time trying to think very hard about what it might mean on a professional basis. The Greek government’s argument seems to be that if the people vote “No” then Europe will need to come back to the negotiating table and agree to significant concessions in order to achieve a deal that sees Greece remain in the euro area. The European view seems to be that if the Greeks vote “Yes” then this is a validation of the need to continue with reform and fiscal consolidation in order for Greece to be put on the path towards long-term fiscal stability. Given the erratic behaviour of the Greek leadership in the last couple of weeks, one thing seems clear, that a deal is more likely to be done if there is a new team representing Greece’s interests. So a “Yes” vote could see political change in Athens and the beginning of intense negotiations on a new bail-out package that would allow Greece to pay its arrears to the International Monetary Fund (IMF), avoid defaulting to the European Central Bank (ECB), work towards an eventual lifting of capital controls and remain in the euro area. As I write, however, there is little clarity on which way the referendum will go. Polls, for what they are worth, show that it is very tight. Now, I don’t know about the accuracy of Greek opinion polls, but what I can say is think about the ability of opinion polls to signal the correct outcome to the recent Scottish referendum on independence and the UK general election. If the polls had been right we would now have a breakaway nation north of Hadrian’s Wall and Ed Miliband would be the prime minister of England, Wales and Northern Ireland.

“Game theory”
Each day and week takes us into unchartered waters as far as Greece’s relationship with the rest of Europe is concerned. The banks are closed, the country has missed a payment to the IMF and it has no money to meet its bond redemptions to the ECB in a couple of weeks. Further new departures from the normal functioning of a European Union (EU)/euro area member are possible. There are many uncertainties in the near term and market participants have little way of contextualising potential outcomes. No country has left the euro area since the single currency was launched. If we get to that point we might already have seen the near collapse of the Greek banking system if the ECB discontinues the Emergency Liquidity Assistance (ELA). A parallel currency might start to be used to enable every day transactions in the face of a shortage of euro cash. It’s also hard to contemplate what the rest of Europe might do. While the negotiating stance of the EU has hardened in the last couple of weeks, can the rest of the community stand by as a member state descends into economic chaos? One take is that Europe is hoping that a “Yes” vote will trigger the collapse of the Syriza coalition and allow a rapid deployment of funding to prevent such an eventuality. It’s quite a mess.

Connectivity
It became quickly apparent in the wake of the Lehman Brothers’ collapse in 2008 that the financial system had become a complex, tangled web of financial connections as a result of the massive growth in leverage, the proliferation of off balance sheet financing vehicles and the myth of risk-reduction through securitization. Everything was linked from Northern Rock to Icelandic banks to sub-prime defaults and government fiscal balances, and we are still dealing with the consequences of disentangling all those connections and making sure that the system never becomes so susceptible to shocks again. Greece, in reality, is unconnected. Private investors outside of the country have largely abandoned any exposure to Greece, most of its debt is held by official institutions. Whilst a big number for Greece, its total debt is small in comparison to euro area GDP. In terms of trade, Greece is minute. Its economic linkages with the rest of Europe, let alone  the rest of the world, are relatively small. So in terms of systemic financial and economic risk, Greece is not in the same league as the shock that hit the world in 2008. This doesn’t mean to say that if Sunday sets off a chain of events that lead to Greece leaving the euro there will be no market impact. In the run up to the Lehman event, US Treasury yields drifted lower through the summer of 2008, but the big moves came in the wake of the collapse when it became clear what the consequences for the global economy were. As I have said, Greece does not have the same potential for global damage, but there is still scope for markets to react. As mentioned above, no country has left the euro. We don’t know how markets will react to that and how much more risk premium should be put on other euro area assets as a result. The consensus view is that what happens to Greece does not have any implications for Spain, Italy or any other peripheral country. Indeed, it is thought that evidence of rapid economic decline in Greece will put off any sympathy for “anti-euro” political parties in other countries. But this can’t be guaranteed. There is little “wiggle” room on the reform and fiscal fronts in Spain and Italy to prevent certain constituents from feeling that they are suffering from the re-balancing of those economies. Anti-euro support is not going to disappear completely, although the fact that the ECB is keeping interest rates very low for a long time will help keep it at a minimum. After all, economic conditions outside of Greece are genuinely improving. Why throw all that away now?

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