Greece is solved….isn’t it’?

For anyone hoping that the well-telegraphed agreement, between the Greek government and the Eurogroup on Friday 20 February, marked the beginning of a period where Greece would not be in the headlines should think again.

Source: Bloomberg

The next four months could be painful, with even more political brinkmanship than what we have witnessed.

The Greek people have, up until that Friday, shown a strong desire to stay within the European Monetary Union (EMU). However, they will not be happy with what they will feel is an outright lack of respect shown by key personal within the Eurogroup.

Clearly Germany has been the dominant force and held all the cards, knowing full well that Alexis Tspiras had minimal leverage at the negotiating table. Future public surveys will likely show a strong change in opinion around any involvement in Europe.

As Irish Finance Minister, Michael Noonan, detailed after the agreement, Greece wasn’t offered any concessions and its banking system would have collapsed if the Eurogroup hadn’t accepted the Greek proposal. German Finance Minister, Wolfgang Schauble, also spoke out (in what appears to be quite a condescending tone) ‘the Greeks certainly will have a difficult time explaining the deal to the voters’, this seems like a very poignant statement, which should resonate with traders.

So it should be understood that all we have seen so far is simply an agreement to negotiate.

We still need to see much deeper negotiations around fiscal targets for 2015 and 2016, plus enactment on structural reforms, many of which were set by the previous Samaras-led government. This is all expected to be finalised by April, with the last and perhaps most perilous step being sign-off in the Greek parliament. Potentially only then can the next loan tranche be disbursed.

This then raises the issue around how Greece will fund itself until the next tranche of bailout funds are handed out in April. Greece has a €1.6 billion loan redemption to make to the International Monetary Fund (IMF) in March and the treasury department has already hit the limit on the level of short-term debt instruments (T-bills) it can issue. This immediate funding issue will need to be addressed with the €15 billion borrowing cap raised, or the April deadline will need to be brought forward to March. Given the magnitude of what’s at stake, it’s hard to see how it will work to this aggressive timeline.

Importantly, Greece faces €6.7 billion in bond redemptions in July and August; so unless there is a firm agreement in the upcoming negotiations, Greece will default.

At this time the scenario is in no way priced into markets, but it can change.

Considering the Syriza party won the recent election on rejecting the 2012 bailout conditions, it’s questionable on whether we actually get a firm agreement over the coming months. Especially since one of the biggest achievements Mr Tspiras can take out of the negotiation was a mere change of name for the so-called ‘Troika’ to ‘the Institutions’!

Perhaps we will have to see a snap election called in Greece, although Alexis Tsipras will firmly argue that he did his best for the Greek people and no other party would have achieved more. The Greek people are well versed on the subject of Europe and would emphasise with this view to a degree, knowing fully well that the hard-lined German stance would give any Greek government little room to live a less austere existence.

Another win for the Greeks will give them scope to reduce the primary surplus target to 1.5% of GDP (from 3% in 2015). Although, ultimately this will do little to reduce the debt burden and we would actually need to see a primary surplus of over 7% for the next decade for the Greek debt load to diminish.

It then begs the question, why continue on this current path? Why continue to provide loans to a country that needs radical growth measures rather than harsh austerity that is not reducing debt levels?

Looking at the scene from afar, it seems that Germany has been efficiently managing Greece out of the EMU since 2012. Germany has been reducing banks’ exposure to Greek debt, and recently agreeing to €60 billion a month in public and private asset purchases from the European Central Bank (ECB). The chance of a so called ‘Grexit’ is high, despite signs of cooperation between Greece and the less influential European Commission.

The trade

The lack of concern in the Spanish and Italian bond and equity markets has shown that the market believes Greek concerns have been ring-fenced by the ECB’s quantitative easing (QE) program. On a net basis, Spanish and Italian banks hold the largest exposure to European sovereign debt (although not Greek debt), so in theory it should receive a sizeable amount of liquidity from the ECB.

German banks hold a €250 billion exposure to European sovereign debt, while the sovereign itself provides the largest contribution to the European Union. In turn it should also receive a high percentage of the ECB’s liquidity. European equities should really outperform from here and fund flows are already suggesting global fund managers are favouring the European markets in a big way.

We are also seeing signs of economic green shoots in a number of key European countries and many feel we could see the start of an earnings per share (EPS) upgrade cycle. The forecast of 12% EPS growth in Europe looks compelling, relative to the US with 7%; the S&P 500 also trading on a sizeable valuation premium.

The Nikkei is the other region that traders should hold a positive, given we could see 14% EPS growth, with the Bank of Japan buying assets to the tune of 1.4% of GDP a month.

With European markets at all-time highs, or multi-year highs, this is clearly bullish and could be traded as such. EUR/USD remains a sell into $1.1500. However, if the next few months show deterioration in Greece’s negotiations with its creditors, then the market will punish European assets in my opinion, with EUR/JPY shorts the standout trade for a move nicely below ¥130.00. ECB QE will provide traders with a chance to buy equities at more compelling levels, if we see a decent correction in the Stoxx 600, DAX, CAC, IBEX and MIB.


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