Had the current Greek episode, where the terms "Grexit", "bank runs", and "funding freeze" are tossed around as casually as black tie event at the Tsipras household, taken place two years ago the S&P, Dax and the Nikkei would have been halted limit down. Today, however, there is barely any move in risk assets because, as conventional wisdom would have it, a Grexit is suddenly a "great thing", and in fact will serve to not only push the EUR higher but send the DAX to all time-er highs (ignoring that it is just the ECB doing the buying).
However, according to UBS' Larry Hatheway, as ever so often happens, conventional wisdom is wrong. Instead the UBS economist and his peers "believe investors are underestimating the risks associated with Greece's difficult negotiating position with the troika. Matters are likely to 'come to a head' in the coming weeks, particularly as the current program must be re-approved and extended by mutual consent at the end of this month."
Here are UBS' conclusion:
- The terms of a compromise are easier to see than the willingness to compromise. At the time of writing, Greece is deadlocked in its bilateral discussions, as well as with the troika members.
- Breaking the deadlock voluntarily may not be easy. Political realities in the rest of Europe argue against granting the Syriza-led government concessions on debt or fiscal relief. Yet the Greek government feels it has a mandate to demand such relief.
- Hence, outside pressure—in the form of financial and market dislocations—seems necessary to focus minds.
- A Greek exit remains the worst case outcome, both for Greece and the rest of the Eurozone. But that logic, alone, may not drive parties to an easy or quick compromise.
- The rising probability that financial pressures will increase—as has already been evident in depositor flight from Greek banks—makes us tactically cautious on risk assets. Our asset allocation team has accordingly cut its allocations to risk assets.
- Contrary to some narratives, an escalation of the crisis or even a 'Greek exit' is unlikely to push the euro higher. We think contagion effects would have the opposite impact.
- In the (still unlikely) event of a Greek exit, Greek banks would not have sufficient capital to address losses and bank lending would likely collapse.
- In a scenario of Eurozone exit, we believe European cyclicals and financials would do worst, while safe haven markets such as the UK or Switzerland would outperform.
There is much to read, digest and ponder in UBS' note "Can Europe avoid a Greek tragedy?" and we will touch on much of it in subsequent posts, although we immediately disagree with UBS' chief contention namely that "outside pressure—in the form of financial and market dislocations—seems necessary to focus minds." That may have been the case in 2012 but now it is precisely the opposite - after all the ECB wants to telegraph that it has not only Grexit but its associated contagion under control (thanks to Q€, OMT, you name it), and as such the worse the negotiations get, the higher the EUR is likely to rise (on ECB and SNB buying) coupled with a rise in risk assets.
Remember: it is all about leverage, and the way the Eurozone is telegraphing its leverage to Greece is by advising Varoufakis that he has none, and if stocks refuse to sell off on any Greek threats, no matter how credible, then Greece clearly has no leverage, and thus has to conceded.
Of course, once the negotiations are over one way or another, and assume Greece is out, at that point the ECB's posturing can end, and the real selling begins once the realization of what just happened - a realization facilitated by the ECB's intervention in the market - then, and only then, will UBS be correct. But the bottom line is that the calmer the market is, the more likely Greece is to actually exit, all courtesy of the now ubiquitous central planning which as we noted earlier, will result in central banks monetizing more than 100% of gross bond issuance for the first time ever in 2015.