‘Crunch time’ is approaching in the stand-off between Greece and the Troika. As of
11 February, the ECB will no longer accept Greek sovereign debt as collateral. On
12 February, Prime Minister Tsipras is scheduled to meet other European leaders in
Brussels. Those discussions will come just two weeks before the 28 February deadline
for Greece to accept the terms of the existing Troika programme. Markets appear to
underestimate the risks of a longer impasse.
A compromise can be found, but will it take stress to achieve?
The ECB’s decision has clearly increased pressure on the Syriza-led coalition
government, whose overtures about debt and fiscal relief haven’t found sympathy with
national governments or the Troika. Yet, Syriza faces a damaging loss of domestic
political credibility if it accedes unilaterally to the Troika’s demands to stay in the
current programme without modification. Oddly, there should be sufficient room for
compromise. An extension of debt maturities on more favourable terms could reduce
the net present value of Greek debt by as much as 17% of GDP, without a ‘haircut’
from creditors. A modest reduction in Greece’s required primary surplus could free up
fiscal flexibility. Small steps, to be sure, but potentially enough for compromise. But the
overriding question is whether compromise will be found freely or be forced by
economic and financial stress, or even fears of a Greek exit?
‘Grexit’ unlikely, but the risks are non-negligible and potentially very large
A voluntary Greek exit from the Eurozone remains unlikely—polls suggest 75% of
Greeks are supportive of continued membership. But if depositors lose faith in the ECB
as a lender of last resort, bank runs could lead to the imposition of capital controls and
even exit. It is far from certain that contagion could be contained. The ensuing
uncertainty could easily derail a brittle Eurozone recovery. Few things are certain except
one: ‘Grexit’ remains by a considerable margin the worst-case scenario for Greece and
for the rest of the Eurozone.
How to play it?
Inside, we assess the implications of various scenarios across asset classes. Overall,
markets are complacent, in our view, about the risk of financial and economic
disruption. Tactically, we opt to cut our exposures to ‘risk assets’ in our asset allocation
portfolio ahead of difficult and contentious negotiations. For similar reasons, we
anticipate that the euro will weaken in foreign exchange markets. Within European
equity portfolios, financials and cyclicals are most exposed, while we believe defensives,
including staples and pharmaceuticals, offer the greatest protection.