While not its base case (unlike JPM and Citi) Goldman Sachs was expecting an adverse outcome from this weekend's negotiations, and admits that this morning's pre-deal announcment "is thus a positive surprise, at least from a shorter-run, tactical perspective." So does is Goldman optimistic now on the outcome of the Greek deal for Europe and the prospects for further Eurozone utopia?
Hardly.
Echoing the harshly bitter sentiment of Wolfgang Munchau (and all non-Eurozone fanatics everywhere) who said that "The Eurozone As We Know It Is Destroyed [16]", this is what Goldman has to say:
In our view, there are two main factors keeping investors sidelined. One is the residual implementation risks involved in the latest arrangements. Political hurdles in Greece and among those creditor countries most recalcitrant to offer concessions without guarantees will leave short-term investors unwilling to bear the volatility from headline news in relatively illiquid markets. The second, of much broader importance, is the accumulated evidence of the inadequacy of the Euro area's present fiscal governance, which takes up too many resources and exposes the whole system to collapse. Unless rectified by credible steps towards greater integration and ex ante risk-sharing, long-term investors seeking exposure to duration will shy away.
In other words, the only thing that could potentially "fix" Europe now, after an episode that may have terminally torn Europe apart following the stark juxtaposition in the "Grexit" reasoning "northern" vs "southern" countries, is closing the loop on Europe's federalization.
Unfortunately, if there is one thing Europe would be least willing to do now is hand over sovereignty to the ultimate decision-maker, which once and for all, was revealed to be Germany.
Unless of course, Germany continues steamrolling all other insolvent, peripheral nations with gradual annexations of national sovereignty as it has just done with Greece, which will be forced to hand over 25% of its GDP in the form of a liquidation escrow fund to Brussels/Berlin to do as it sees fit.
Here are the key sections from the just released Goldman note:
Looking aheadOn Friday we argued that the chances of Greece and its creditors coming to a fully comprehensive agreement over a new multi-year third programme over the weekend were low. Nevertheless, we expected that an accommodation of some form would be found to forestall the definitive 'Grexit' that had threatened. Overall (and recognising that, even if modest, procedural risks remain), the outcome announced this morning is thus a positive surprise, at least from a shorter-run, tactical perspective.
Yet looking ahead, the acrimonious process of reaching agreement has done little to re-establish trust among the various parties. Indeed, the opposite is likely the case. And frictions have emerged among the creditor countries (e.g. between France and Germany) over how to treat Greece and what implications that will have for the stability and resilience of the Euro area as a whole going forward.
With the economic situation in Greece deteriorating, substantial implementation risks to the new programme remain. Greek banks are likely to remain subject to controls for some time, even if -- as we expect -- the ECB Governing Council sustains the current level of emergency liquidity assistance while banks are restructured. Domestic political pressures against further adjustment and austerity will continue to mount. As we have seen in the past, the scope for the Greek authorities to backtrack from programme commitments once the financial support is flowing is high. After the events of the past few weeks, tolerance for such recidivism is likely to be extremely low. Greece will be kept on a short leash with invasive monitoring by the creditor institutions.
Greek membership of the Euro area over the longer term therefore remains in question. Even with a new programme, the substantial economic and political challenges facing the adjustments required to make Greece's fiscal, competitive and employment situation sustainable still need to be addressed. And despite measures in the new programme to boost investment, restoring growth to Greece remains a formidable challenge.
Yet the broader market is increasingly able to separate Greece from the rest of the Euro area. Particularly with regard to sovereign spreads, the impact of the recent Greek saga has been relatively modest, owing to some combination of: (a) expectations that a deal would be reached eventually; (b) the credibility of the ECB's backstops and willingness to do "whatever it takes"; and (c) the recognition that (now that direct private sector exposures to both Greek banks and sovereign have been reduced) Greece no longer poses the contagion threat it did in the past.
While Greece itself will remain in the news, we expect it will become less of a focus for broader market developments.
Market implications
The response in markets to the news of a 'deal', conditional on further 'prior actions' on the Greek side, has been tepid. This is broadly in line with what we wrote in our note last Friday, where we argued for the marathon negotiations to extend beyond the weekend.
In our view, there are two main factors keeping investors sidelined. One is the residual implementation risks involved in the latest arrangements. Political hurdles in Greece and among those creditor countries most recalcitrant to offer concessions without guarantees will leave short-term investors unwilling to bear the volatility from headline news in relatively illiquid markets. The second, of much broader importance, is the accumulated evidence of the inadequacy of the Euro area's present fiscal governance, which takes up too many resources and exposes the whole system to collapse. Unless rectified by credible steps towards greater integration and ex ante risk-sharing, long-term investors seeking exposure to duration will shy away.
We have used the 10-year government bond differential between the average of Italy/Spain and Germany as a gauge of intra-EMU sovereign risk. Our baseline economic forecasts, reinforced by the effects of QE, suggest that there is room for the spread to tighten below 100bp. In coming weeks, however, we continue to see the spread range-bound between 100 and 120bp.
In the near term, the main focus will be on the 'bridge financing' to avoid a default on the ECB on 20 July as this would compromise the chances of seeing a relaxation of the ELA. Then attention will shift to the treatment of the Greek banks, and the potential read-across to other resolution cases. On balance, we do not think that deposits and senior secured bond holders will be bailed in. Finally, attention will move to the terms of debt relief as discussion will take place as to whether they will be applied to other former program countries (our answer is, probably yes).
Should negotiations collapse -- a smaller probability outcome at this stage, but not a negligible one either -- we think that spreads would go to 200-250bp (i.e. 10yr yields back at 3perc) before the ECB intervenes to push them back down.
