Greece and the euro: Short term reprieve, long term issues!

So, as we are lead to believe from the official projections, the tail risk or potential immediate disaster story of an anti bailout (and tacit anti euro) vote in Greece has been avoided with the narrowest of margins.

The suggestion now is that having avoided the complete dismissal of the traditionally dominant political parties, that New Democracy and Pasok put aside their (significant) differences and in exchange for continued support, and likely further concessions from the eurozone, form a coalition government over the next couple of days. I would expect this to come sooner rather than later.

Although some commentators myself included are far from convinced that the likely ‘old guard’ coalition will be able to prevent the train crash from occurring (with an insurmountable debt pile, huge unemployment, unit labour costs 30-40% above where they need to be to be competitive and a lack of confidence that will continue to deter inward investment), it will likely now occur at a slower pace.

The broad financial markets are therefore likely to breathe a loud sigh of relief that we are not waking up this morning to the potential ejection of a eurozone member state. However, as I see things, this is far from a positive development in any way shape or form. However, in the short term we may see some form of relief rally in risk assets as those who positioned for the ‘worst’ unwind those trades, in the longer term the picture is far from rosy.

Which way now?

I would expect that the first couple of trading sessions will be fairly tentative as we await final confirmation of the official situation and bipartisan agreement from the proposed coalition. For today I would also expect banks to outperform the indices, as the threat of a sovereign default will appear reduced. However, the key barometer of market sentiment is likely to be the yield on Spanish and Italian bonds. If 7% becomes pressured again in Spain, then the turnaround in sentiment could come much quicker than anticipated!

Supportive rhetoric and the promise of co-ordinated action to do ‘all that is needed’ eminating from the G20 will help sentiment and risk assets at the start of the week, but while I remain in the glass half full camp for the UK, the eurozone situation has to remain the number one global economic concern.

“The engines of world growth are running out of steam, while the trailing wagons are going off the rails” – Professor Prasad (Cornell University)

The G20 will now likely take centre stage as expectations for an increased global contribution to the IMF, and an agreed additional concession for Greek debt maintenance, add to the near term positives.

For the rest of the week there are a number of data releases and events that will keep market participants on their toes, with economic sentiment out of Germany in the form of both IFO and ZEW indices and from the broader eurozone in terms of PMI data. As I see things, these are likely to put the emphasis back on growth and the sharp deceleration (or negative acceleration in some cases) of growth. Again the key barometer of the reaction to the data and the broader economic backdrop is likely to be Spanish and Italian 10 year bond yields.

In the UK and the US, the focus of attention will come back on the possibility of further QE. In the US, explicitly at Wednesday’s FOMC policy meeting, where in light of the relief in Europe we are unlikely to see anything more than an extended ‘twist’.

In the UK, expectations of further QE will rise or fall via expectations after Inflation, employment and retail sales data, and the commentary and rhetoric from the previous UK monetary policy meeting from Wednesday’s release of the minutes. GBP may suffer initially if the data and official rhetoric suggests more QE is on its way, however, history suggests that GBP outperforms on the implementation of QE and thus I maintain my underlying call for GBP to outperform.