First, a quick recap of what happened yestrday, courtesy of the WSJ:
#1: Germany Got What it Wanted, for Now
Germany spent the last few weeks insisting that it wouldn't scrap the bailout program and still lend money to Greece. The new left-wing government of Alexis Tsipras insisted that it wouldn't extend the program and instead sought some "bridge" financing from the eurozone. In the end, Greece asked to extend the program and pledged to follow its rules. The extension lasts until the end of June, just weeks before Greece must make several large debt repayments.
#2: Greece Got the Prospect of Some Leniency
First, the eurozone appeared to offer some leeway on Greece hitting its budget target for 2015. Given the sharp deterioration in the Greek economy and government tax receipts, that seemed inevitable. The eurozone statement also doesn't repeat the budget targets for future years of the existing program, which call for the government to run a surplus, excluding interest payments, of 4.5% of gross domestic product. Relaxing that requirement had been one of Mr. Tsipras's main goals.
#3: The Deal May Not Hold
By the end of business Monday, Greece must submit a list of legal overhauls that it wants to adopt, based on the current program. Mr. Tsipras has said he wants to replace many of the mandated changes. But a number of the ones he dislikes most--such as cuts in pensions--are also the ones considered most vital by the eurozone and the IMF. If the eurozone doesn't like his proposal, ministers will meet again to discuss their next move.
#4: Greek Politicians May Reject Deal
The deal appears to go against some of Mr. Tsipras's campaign pledges. Greece will still be subject to oversight by the European Commission, the IMF and the European Central Bank, whom he had vowed to kick out. Rejecting such conditions would have left Greece without access to funds and at risk of its banks being cut off from the ECB. That could have forced Greece from the eurozone, something the Greek public still opposes. But Mr. Tsipras's Syriza party and his coalition partner may not be happy.
#5: Greece Will Need More Money
Running lower budget surpluses this year, and possibly for years in the future, means Greece will need more funds. Eurozone officials have said they may lower interest rates on loans given to Greece, but it is unlikely to be enough. There is only around EUR15 billion ($17 billion) left in Greece's bailout, around EUR10 billion of which is in a fund for Greek banks. As it stands now, the deal says those funds should be reserved for the banks and not for financing the Greek government.
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And next, courtesy of Peter Tchir Of Brean Capital, is one outlook on What's Next For Greece, The Euro, And Markets?
I’m sure that at this stage everyone is sick and tired of hearing about, reading about, or even thinking about Greece and GrExits, but it is impossible not to spend a couple of minutes looking at Friday’s “deal” and figuring out what that will mean for the future.
Garanimal 30%: These “mix-and-match separates makes clothes easy to pair and fun to wear” is my new term for the optimistic outcome. Greece starts aggressively collecting taxes, makes progress on other “hot button” issues for the rest of Europe and gets a package designed for long term sustainability. I think we see European equities rally. European bank stocks rally. Credit spreads narrow considerably, and very quickly, a new deal is cut for Portugal. That is followed by renewed efforts to kick-start the economies of Spain and Italy. This would all be very good, and is possible, but already seems like the market is putting a higher probability on this occurring than I am. Greek bonds should do extremely well in this case. For the Euro, I think I can create believable scenarios that have a short covering spike higher on the back of this sort of watershed event, but I can also think of plausible reasons why it would resume its QE inspired downtrend.
GrExit 40%: I put the likelihood of a Greek exit at 40%, making it my most likely scenario. The 4 months is merely an attempt by both sides to revamp their plans for an exit. On the bright side, that considerably increases the likelihood of an orderly exit. They have to renegotiate the terms of all their existing loans from Euros into Drachmas (they should probably do the same with the bonds, but the loans are their big issue). That way the rest of Europe can still say they are getting paid in full – just in Drachma at likely an overly generous conversion rate, rather than in Euros. Greece CANNOT start a new currency and keep all of its outstanding debt in Euros. It would also give the ECB (probably with strong encouragement from the Fed) the time to create a realistic way to make the transition palatable for the banks – the Greeks will need solvent banks in the new world order. I believe that an orderly exit is fine, and I think with 4 months to do it, they are 75% likely to find a solution that works for everyone. Given all the parties at the table, the precarious status of some of those parties (political or financially) there is a risk that the GrExit is messy, which I put at 25%. While the markets should largely be able to ignore a well negotiated reasonable exit strategy, it will encourage parts of Spain, Italy, Portugal, and possibly even Finland to discuss exiting the single currency (they will want to maintain as many benefits of being in the EU as possible, without the currency or some of the more onerous regulations). Under the good exit scenario, risk assets in Europe struggle to continue their strong performance (the CAC, DAX, MIB, and IBEX are all up 10% to 15% this year). The new “better” Euro appreciates as investors start to bet that other weak members, requiring the most ECB support, also look to leave, making the Euro look more and more like the Deutschemark and crushing the large short base. The “messy” Grexit scenario hurts all risk assets as questions arise about who will pay what debt and when. Even with QE, I would expect selling of periphery debt and I think the Euro would drop precipitously as investors fled Euro denominated assets in droves. So maybe this is actually two scenarios – the Good Exit and the Bad Exit.
Kick the Can 25%: The Germans, who apparently have a word for everything, also have a work for Kicking the Can – its “EU Summit”. There is no group that is better than kicking the can the EU, and betting on any summit resulting in a statement that sounds great, that is really more just can kicking is usually the odds on favorite. I put that at a reduced probability this time around, as it might be causing more instability at home for many politicians, rather than less. Having said that, the prospect of potentially working through July and, horror of horrors, August, could be daunting enough that another 4 month kick could be given – especially if Greece makes some progress, just not enough. Remember, the EU “bailout” largely goes to cover paying back previous EU, ECB, and IMF loans. Some is new debt to fund the country, but that is the smaller amount. This is more of the same. If this scenario looks likely, expect more small moves in all asset classes – the moves will be relatively small and particularly vicious – and feel random after the fact – just like the past 3 weeks. It would warrant fading any strong view either way without sufficient evidence.
GerExit 5%: While this seems like such a low possibility, it does seem that Germany is becoming more and more isolated from the rest of Europe (with the possible exception of Finland which seems even more separated, both physically and fiscally). Is there a point where Germany just decides that “I’m going to take my ball and go home!” Does it get too tiring being the “only adult in the room” or at least believing that you are the only adult in the room? Does Germany believe that its system is superior enough to withstand the immediate pain from moving to a much stronger currency? Would they be more comfortable dealing with the issues of having a the Bundesbank run a new Deutschemark instead of feeling that they have to constantly act as the police of the European banking system? At some point, does the feeling that they are the only owns really sticking to the original plan become so frustrating that they decide it isn’t worth it? Would a German exit from the Euro be welcomed by others? In theory, a Euro without Germany and maybe some other strong members, would sell off dramatically. It should help the rest of the countries become more competitive, and if they still allow visa free travel, it won’t hurt the tourist trade as relatively rich Germans still come to the Mediterranean to spend their shiny new Deutschemarks. This seems like a very low probability event as Germany has been a key architect of the Eurozone and done so much to keep it together, but, it does in many ways seems to solve the issues faster and more conclusively than any solution focused on Greece.
What This Means For Trading
I think Friday’s outcome and the potential future outcomes boil down to a few simple things to consider
- Friday’s bounce was rather weak. The S&P and NASDAQ both only managed to climb by 0.6%. Since Europe had already closed down for the weekend, almost all the short covering related to announcements would have to have been done in the U.S. market – making the pop even less compelling. A classic example of “buy the rumor, sell the news”? Treasuries still wound up the day only unchanged as well.
- Unless someone senior from Greece says they are defaulting, or someone senior from Germany says they are kicking Greece out, any headlines from Europe should be ignored. Over time which of the scenarios seems most likely should play out, but until then, this is mostly noise.
- I will be looking to see how Spain reacts – will Rajoy’s opposition view Greece’s extension as a victory for Greece and put renewed pressure on Rajoy? Will the Greek people feel like their leaders sold out too quickly and try to put an actual radical party in charge? It seems that a few days of EU Summits can take the radical out of a party.
- We can now focus on the domestic situation. On earnings and growth and what it means to have a Fed far more interested in “normalizing” policy than intervening at every market blip?
Be Careful What You Wish For
Yes, we are all sick and tired of the incessant Greek headlines, but I am not so sure we will like what we see when we resume focus on our own economy
I have to admit that the chart is far less compelling on a longer term time horizon, but I wanted to end this note with a good segue into the new “meme” that I expect to dominate the news waves over the coming weeks – what is going on with the U.S. economy and is it really as good as the last NFP report suggested?