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With negotiations continuing we may see sharply increased levels of volatility in the coming days. You may wish to reduce or hedge your market exposure in advance of any potentially significant events, or deposit additional funds onto your account to provide extra cover for your positions.
My personal belief is that those previously calling for Greece to leave the European Monetary Union would not have changed their call; in fact they would even argue their case has strengthened. It really seems as though Germany is slowly managing Greece out of the Union, although this process probably started back in 2012 by reducing banks’ exposure to Greek debt.
To put Friday’s developments into context, all we have seen so far is simply an agreement to enter into what will no doubt be complex and painful negotiations. Judging by our client flows today, traders have been only modestly enthused by the agreement, although the European market open is shaping up to be a positive affair.
The idea that the Greek government will ultimately sign off on the sorts of fiscal targets and structural reforms that will satisfy the hard-lined stance of the Eurogroup is yet to be seen. So, while this may indeed lead to a snap election, Greece will also be cognisant that it faces €6.7 billion in bond redemptions in July and August; so unless there is firm agreement in the upcoming negotiations, then Greece will default.
Will Greek negotiations even make April?
Negotiations may not even make it to the proposed deadline of April, as Greece doesn’t actually have enough money to make a €1.6 billion loan redemption to the IMF in March. What’s more, the Greek Treasury Department has already hit the limit on the level of short-term debt instruments (T-bills) it can issue. So the immediate funding issue will need to be addressed with the €15 billion borrowing cap raised, or the April deadline will need to brought forward to March. Given the magnitude of what’s at stake here, it’s hard to see how Greece can work to that aggressive time-line.
Still, the European Central Bank’s (ECB) quantitative easing program kicks in next month and this seems to be the key driving mechanism. Valuation wise, Europe is trading on a valuation discount to the S&P 500, while earnings are expected to grow 12%. There are even signs of economic green shoots emerging, which could drive a potential earnings per share (EPS) upgrade cycle, something that traders just don’t associate with Europe. What’s more, European banks have underperformed of late, but I feel that will change as the central bank showers European banks with liquidity, understanding that some 70% of domestic companies’ external funding comes from the banking sector. This sounds reasonable, but in the US, corporates generally source funding from alternative sources (such as the markets).