Grexit? No Grexit?

9/2/2015

By Chiara Albanese

After a whirlwind tour of European leaders last week that many hoped would sow the seeds of compromise between Greece and its creditors, the country’s new Prime Minister, Alexis Tsipras, has come back with one message: He will undo austerity measures imposed by European partners as a condition of its bailout, and doesn’t want an extension of that bailout. He does want a bridging loan and time to restructure.

Greek markets weren’t happy. The Athens stock index sunk 5.4% this morning and yields on 2 year bonds rose to more than 21%. Short-term yields rise when investors worry about a default.

So is this all bad news? Well no, according to some of the strategists watching this situation most closely.

“Concerns of Greek exit remain exaggerated,” said Alberto Gallo, head of European macro credit strategy at Royal Bank of Scotland Group PLC.

While it is true that Greek debt is unsustainable, the eurozone remains an incomplete union, with a common currency, but no fiscal and political union, he said. “The cost to Germany and core countries to let Greece exit remains extremely high compared to a restructuring of its debt,” according to Mr. Gallo. He says Greece needs around €60 billion ($67.8 billion) restructuring in its public debt.

RBS is currently rating the probability of a Grexit to below 10%, and the bank continues to remain invested in peripheral debt. RBS is long Italy and Spain triple-B long-dated bonds, while it remains underweight on Greek and Portuguese debt given the volatility and risk of contagion.

“There are political considerations as well: an exit is only possible with a referendum, and most Greeks, 70 to 75%, want to stay in the eurozone,” he said.

“We see good scope for compromise,” said Reinhard Cluse, chief economist for Europe at UBS AG. He added the negotiations between Greece and its European partners  will be influenced not just by sober calculations of cost and benefits, but will also be exposed to the cross-currents of psychology and domestic politics. “This implies a non-trivial risk of miscalculations and eventually policy error,” he said.

Room for compromise could be found by charging lower interest rates on Greece’s bailout loan and a greater budget flexibility, UBS said.

Eurozone economists at Bank of America Merrill Lynch remain confident that “in the end, reason will prevail”.

While the Greek Government and European authorities are far from any potential agreement, they said, “we have seen some steps in the right direction,” even if a long period of discussions, headlines, and volatility is unlikely to be avoided.

Obviously not everyone shares the optimism. Former Fed chairman Alan Greenspan said on BBC radio this weekend that “it’s just a matter of time before everyone recognizes that parting is the best strategy.”

U.S. Treasury Secretary Jacob Lew has urged Greece the Europeans to “tamp down the rhetoric a little bit.”

Eurozone assets, meanwhile, remain exposed to the political noise with all major stock indexes driven lower Monday by the ongoing uncertainty over Greece’s faith. The Stoxx Europe 600 index was 1.1% lower. Germany’s DAX fell 1.5%, while Spain’s IBEX 35 sank 1.7% and Italy’s FTSE MIB slipped 1.7%.

UBS has for now cut its exposure to risk assets, anticipating further weakness for the euro, and with an eye on the potential impact of contagion if Greece does indeed exit.

“Even if the damage of a potential Grexit might not be quite as severe as it would have been in 2011/12, it would still create substantial turbulence,” UBS said.

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