JP Morgan Asset Management duo ask: Greece stays in, but what now?
Dan Morris, Global strategist and Nick Gartside, International CIO for Fixed Income at JP Morgan Asset Management have mulled over the fundamental challenges facing Greece and other eurozone members.
The outcome of the Greek election was better than investors had feared. While the pro-bailout parties could have secured a more convincing majority, it appears likely that they will succeed in forming a coalition, meaning that Greece is likely to remain in the euro, at least for the time being.
The election result did not produce a significant relief rally on stock markets – perhaps unsurprisingly, as the fundamental issues, not only for Greece but also for Spain and Italy, are unchanged. Nonetheless, the news is positive for investors. The existential risk to the eurozone has receded, and there is greater optimism that the crisis can be managed from here.
Greek problems becoming more contained
Following the election, we are somewhat less concerned about the implications of Greece’s debt problems for the eurozone as a whole. Greece is quickly running out of cash, tax receipts have fallen and a significant proportion of the population continues to oppose the terms of the bailout. But with a pro-bailout government in place, these issues can be managed within the context of the eurozone.
It has been obvious for a while that Greece will need additional aid. With political uncertainty receding, there is now perhaps a little more sympathy on the part of the Troika (the European Commission, the European Central Bank and the International Monetary Fund) for amending the terms of the bailout and providing further support. Greece undoubtedly faces some difficult years, but we think its troubles will become more contained.
Implications for bond markets
As fixed income investors, we are assessing the Greek election result through two filters: politics and the economy.
The election result was at the upper end of the scale of possible outcomes, but from a bond market perspective Greece has merely been restored to the position it was in a few months ago. The governing coalition has a fairly narrow majority, and is likely to be fragile.
Greece is running a deficit of over 9% and the economy is expected to contract by around 5.5% in 2012. Unemployment is at around 22% and wages are forecast to fall about 5% this year. This economic position is even worse than was expected even a few quarters ago, emphasising the recent deterioration.
The outlook for Greece therefore continues to appear bleak. Nonetheless, funding costs for Greece – and for other bailout countries – may come down a little now that the election is out of the way, and loan tenors may be extended somewhat.
For bond investors, the most significant outcome of the election is that worries about whether euro membership is reversible have receded. A different result at the weekend would have opened up questions not only over Greece’s membership of the euro, but over other countries too. It is important that this issue has been put to bed.
From the perspective of fixed income markets, Spain – a much larger market than Greece – is by far the most significant source of concern. Spain is suffering from three key weaknesses: its public finances (the Spanish budget deficit keeps being revised upwards), the fragility of its banking system, and sovereign debt stress. With each of these weaknesses reinforcing the others, Spain looks fragile.
More broadly, for bond investors, we expect yields on core government bond markets to remain low for a significant period. The highest conviction opportunities we are identifying at the moment are in credit, particularly investment grade credit. Corporate fundamentals are strong, and investors are being well compensated for risk by very attractive yield spreads.