29 Jun 2015
Recent events in Greece
The Greek negotiations continued into the weekend following the postponement of bailout talks in order to unlock a 7.2bn euro aid payment. Without agreement, a run on banks and a Greek default would ensue, damaging the rest of the Eurozone.
The group of Eurozone finance ministers and the Greek PM failed to reach agreement at four separate meetings held last week. It appeared as though the Greeks had accepted some proposals such as a lift in the retirement age, limited cuts to pensions and broadening of the tax base, but were holding strong on demanding a debt restructure (some debt forgiveness) and the removal of the requirement to continue running primary (net of interest and debt payments) budget surpluses.
Rumours had been circulating that Eurozone officials had already begun readying plans, such as capital controls and humanitarian aid, to ring fence Greece in case an agreement was not reached. A deal on the weekend was imperative, as there would not be enough time for the economic reform measures to be passed by the Greek parliament and have the aid program extended before it expires on 30 June.
As it stood (and currently still stands), the Greeks wouldn’t be able to make a 1.5bn euro loan repayment to the IMF on 30 June without the aid. If the Greeks defaulted, it would then put pressure on the European central bank to stop propping up the Greek banks in order to keep them capitalised and avoid bank runs.
The events of the weekend changed everything. Surprisingly and without notice, Greek PM Tsipras halted all negotiations with creditors and announced a Greek referendum. Voters have been given the proposals (90 odd pages of very technical language) from the creditors and have been asked to vote for or against them.
The vote only makes sense if you’re PM Tsipras. He largely wants to agree to the proposals, but he can’t without losing power from within his own party and from losing some of his voter base. So instead, he puts it to the people where he won’t be held accountable – they make the decision. In addition, he orders all banks to be temporarily closed – whilst this is required given the banks will run out of cash, it also encourages voters to vote for the creditors’ proposals.
There are now three possible scenarios:
1. Greece wins (unlikely) – Eurozone partners make big concessions involving writing off some of Greece’s debts and softening up on some reform requirements. This is likely to lead to other struggling peripheral countries in the EU asking for the same assistance. Radical parties similar to Syriza in Greece will likely gain ground in other countries in the Eurozone. In addition, anti-EU parties would gain support at the EU level making it near impossible for the EU to reach decisions, thus putting the EU and possibly even the euro at risk.
2. Greece exits (possible) – Greek voters vote against the proposals or the creditors revoke their deal; Greece defaults on its debts and leaves the euro as a result. The Greek banking system collapses, the drachma replaces the euro and is depreciated, thus stoking hyperinflation. The concern is that this provides an example for others to leave the euro, may cause some contagion and also raises questions about the future of the whole Eurozone. However, this may actually lead to a stronger euro as EU policy makers would likely push for deeper integration amongst member countries.
3. Greece folds (possible) – Greek voters vote for the proposals; Greece is forced to continue paying back debts and make fundamental reforms. The problem with this approach is that Greece actually can’t pay back the debt given its size and the reforms (as per the creditors’ current demands) would push Greece to the poverty line. In addition, if these reforms are pushed through the Greek parliament, PM Tsipras could be toppled (though the referendum should save him), possibly along with his Syriza government, making room for a more radical party to take power in Greece.
Markets will be choppy until some clarity is gained from Greece. We shouldn’t see a massive fall in markets as the consequences of Greece leaving has little to no impact on equities with little to some impact on bonds. It’s the uncertainty that markets don’t like, and the risk of contagion – hence, they will react, but should then move on from it.
You will see a lot of central bank talk this week with central banks promising to do what it takes to stabilise markets. China has already moved over the weekend by adding further stimulus to their economy (cutting interest rates).
We think a variant of scenario three is most likely – i.e. the Greeks fold, but with the appearance that concessions have been made on both sides so that everyone feels/appears victorious. But given events of the weekend, it may be anyone’s guess.
Time will tell.
Next steps for interest rates in the US
Economic data in the US has begun to show improvement from the poor fourth quarter last year and the disastrous first quarter this year. Most of this poor data was a result of inclement weather (some of the coldest days/weeks/months ever recorded) and the strongly rising US dollar.
More recently, we’ve seen an improvement in housing and employment data, slightly higher inflation with wages beginning to rise, stronger manufacturing activity, and rising consumer and business confidence.
This has put the US central bank (the Fed) back in play, looking at their first rate rise in nine years. They flagged at their June meeting that they were ready to raise rates given the improving trajectory of data. There are only two occasions left this year in which the Fed can/will raise rates: September and December. These are the only two meetings where a press conference is held afterwards where the Fed will want to explain their decision making.
We think a September 0.25% rate rise is likely, but not necessary. The Fed will want to begin to set expectations that they are serious about returning to a more normal rate setting (currently at 0%) and will also want to see how the market and the economy react to the rate rise.
The timing of the first rate rise is largely irrelevant. It’s the pace of future rate rises that is most important for the global economy and investment markets.
We think the Fed moves very slowly after the first rate rise for multiple reasons: government debt levels are still too high (higher rates mean larger interest payments), the economy is still fragile and can’t handle higher rates, inflation is and remains well and truly under control (even so, the Fed has indicated they are comfortable with inflation running at higher than previously acceptable levels), and higher rates will push the US dollar even higher thus crippling US exporters and hurting corporates with significant non-US dollar earnings.
A slow moving Fed is supportive for growth assets such as equities and property.
If you have any further questions about how these events may affect your portfolio, please don't hesitate to contact us.