Since our comments on Greece last week, events have further intensified for all of the key players, but most notably the Greek people themselves. The Greek Government has called a referendum, negotiations have totally collapsed, capital controls are now in effect, a payment due to the IMF has been missed and the bailout programme at the centre of the crisis has expired. All sides are now holding their breath waiting for the outcome of the referendum on Sunday, which could well be the major turning point in a political crisis many years in the making.
The Greek Government found itself caught between a rock and a hard place, bound by a mandate to reject austerity and achieve debt restructuring which has proven totally incompatible with creditor demands to stick, essentially, to the original agreement in exchange for much-needed bailout funds. Unable to reconcile these two factors, the Government is now turning to the Greek people to decide the way forward. Ostensibly, the referendum asks whether or not Greece should accept the latest creditor demands – on a programme that has already expired. In reality, a ‘Yes’ vote will likely pave the way for Greece to re-open for business within the Eurozone, returning to relative normality – unsatisfactory as that may be for many. There is also a strong possibility that a ‘Yes’ vote will force a change of leadership in the Government, arguably the outcome that certain other Eurozone leaders have been hoping for.
A ‘No’ vote is likely to be considered the point of no return. Greek banks remain reliant on liquidity provided by the ECB, but as its President Mario Draghi has pointed out, the ECB is a rules-based institution, and one of its critical rules is on solvency. In the event of a ‘No’ vote it would be very difficult to argue that Greek banks remain solvent, which could lead to further withdrawal of support, accelerating the country towards a messy exit from the single currency.
How would a ‘No’ vote affect markets? In terms of direct impact, we believe this will be relatively limited. A number of European banks have some exposure to Greece – either through holding Greek securities or through derivatives related to Greek assets – however, these are believed to be small in scale as banks and official institutions have spent the last few years reducing cross-border exposure given previous turbulence in the Eurozone. The risk of contagion is also much reduced thanks to the defences that the ECB and other institutions have spent years putting together, which include Quantitative Easing (QE) measures and the Outright Monetary Transactions (OMT) programme which was a major part of Draghi’s “whatever it takes” initiative in 2012.
We do, however, remain concerned about broader complacency in markets and the current poor liquidity conditions in many asset classes. A ‘No’ vote could shatter this complacency and sorely test current market conditions. Thus the key risk we see coming out of the Greek referendum is the effect it could have on sentiment rather than any material macroeconomic effect. Within our asset allocation guidance, we have recently taken a more defensive stance, which has included favouring more liquid parts of both equity and bond markets.