Regardless of Greek Election Result, Euro Exit Not Likely

When this Wednesday’s special election was called last week, markets swooned a bit. While fears of a euro exit remain, the present situation is not cause for alarm.

Greek Finance Minister Yannis Stournaras Interview

A European Union (EU) flag flies beside a Greek national flag near ancient carved stone sections of a Greek column in Athens, Greece, on Monday, March 31, 2014. The European Commission predicts the Greek economy will grow in 2014 for the first time in seven years, and the nation is now looking to start selling debt again next month after achieving a budget surplus last year. Photographer: Kostas Tsironis/Bloomberg

Kostas Tsironis/Bloomberg

The decision by embattled Greek Prime Minister Antonis Samaras to shore up his authority by calling a snap presidential election two months early, to be held this Wednesday, has certainly produced a shock — but, despite the possible outcome, not much in the way of shock waves.

The coalition led by Samaras’s New Democracy party has a small majority in the Hellenic Parliament, but some of its members — unhappy with Greece’s economic austerity measures — may vote for the opposition leader, Alexis Tsipras, whose leftist Syriza party is leading in the polls. If Stavros Dimas, Samaras’s preferred candidate, doesn’t secure the support of at least 60 percent of parliament, the prime minister will have to call a general presidential election more than a year ahead of schedule.

The two parties could not be further apart. New Democracy is cooperating with the bailout inked with the troika of the European Union, European Central Bank and International Monetary Fund, with part of the agreement set to end in two months. Syriza opposes the austerity that the troika has demanded in return for saving Greece from defaulting on its debts. If Syriza’s rhetoric is taken at face value, a Greek exit from the euro would seem inevitable. But Tsipras has toned down his speeches in recent weeks, going so far as to vow that a Syriza government would not run a deficit.

Greece’s stock market plummeted by 12.8 percent, its largest one-day fall in a quarter century, on December 9 when Samaras announced the move. The FTSEurofirst 300 dropped a considerably more modest 2.3 percent that day. The yield on ten-year Greek bonds shot up 61.8 basis points to 8.733 percent, while the yield on ten-year German Bunds fell 0.8 basis points to 0.682 percent as investors fled from peripheral European debt in a move to apparent safety. In total, yields on ten-year Greek debt jumped 180 basis points over the week to close at 9.15 percent on December 12.

While the yield of Greek bonds soared, those of other bonds in the euro zone periphery rose modestly. The yield on Spanish ten-year bonds was up 4 basis points last week, closing at 1.88 percent, while Italian ten-year bonds rose 8 basis points, ending December 12 at 2.06 percent. “The moves [in peripheral bonds] have not been as violent as in the past,” says Patrick O’Donnell, fixed-income portfolio manager at £324.4 billion ($525.9 billion) Aberdeen Asset Management in London.

This relative calm in other European markets largely reflects a sense that, in the end, Greece will not leave the euro zone — there will be a deal of some kind.

Greeks know that it is not really feasible for the country to leave the currency union, say investors, because it would lead to a collapse of the banking system as depositors fled accounts due to be redenominated in drachmas — and to general economic ruin. A recent more moderate tone in Syriza’s comments suggests that the party is coming around to the idea that Greece has to remain in the euro zone.

“The political suicide angle isn’t a great vote winner,” says Alan Wilde, head of fixed income at €36 billion Baring Asset Management in London. Wilde believes that the probability of a Greek exit from the euro is low. Investing in Greek bonds now “could prove to be quite a rewarding strategy over the next three to six months,” he says, adding that Baring clients are not keen on adopting such “a higher-risk strategy.”

The relative calm of financial markets also reflects a sense that a Greek exit would be less dangerous for the euro zone as a whole. Unlike the Greek financial crisis three years ago, “now there’s some hope you could get a Greek exit without people necessarily assuming the whole single European currency comes tumbling down,” says David Stubbs, market strategist at $1.7 trillion J.P. Morgan Asset Management in London.

Investors are encouraged by the ECB’s repeated willingness to support the debt markets of countries like Greece and Italy. They are also increasingly confident that the banks of other peripheral euro zone countries could withstand the financial market trauma of Grexit, the slang term for a Greek exit from the euro. This year’s Asset Quality Review by the ECB of large euro zone banks has further strengthened that belief.

Some investors continue to ask if the bond market is a bit too relaxed, however, and regard this as a rather low risk premium, even if the likelihood of fiscal crisis or even euro exit now seems much lower than before. “It wouldn’t be pleasant for euro zone government bonds if Greece left the euro,” says O’Connor of Aberdeen Asset Management. Though because of the “backstop” provided by the ECB and other EU institutions, he predicts that they would not reach the double-digit levels that some did previously.

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