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Investors Fear More Uncertainty Ahead for the Euro Zone

Greek election rally fades as fears return that there is no resolution of euro zone debt crisis in sight.

The relief rally that followed Sunday’s rather limited victory for euro zone unity in the Greek general election has proved unusually faint-hearted and short-lived, with the euro down sharply against the dollar despite initially climbing to a one-month high.

The yield on Spanish ten-year bonds also shrugged off the news, rising to a euro-era record above 7 percent.

On Sunday the New Democracy party, which supports the international bailout of Greece, overturned the consensus prediction held only a few weeks ago by pushing the Syriza party — which advocates walking away from the rescue package — into second place.

Analysts suggested that European markets’ downbeat reaction to the Greek result partly reflected the fact that the hard-pressed Balkan nation is merely one worry among many. There is a more general sense of anxious bewilderment about the future size and shape of the euro zone, given the continuing lack of any agreement in Brussels or Berlin on a dramatic intervention that would boost the economies of debt-ridden member states including Spain, Italy and Portugal, as well as Greece. “Uncertainty is the only certainty,” said  Société Générale in a note that summed up the prevailing post-election mood.

However, Greek assets bucked the general European trend by gaining value on Monday — though from an extremely low base, after months of taking a beating. The Athens Stock Exchange composite index climbed 3.6 percent to 581. The National Bank of Greece — the country’s largest bank — soared by 11.1 percent to €1.50 ($1.90) on hopes that the election result will stem the country’s accelerating bank run by providing a clearer future for the Hellenic Republic. The yield on Greek 10-year bonds sank 77 basis points (bps) to 26.48 percent.

But the euro was down 1.1 percent against the dollar to €1.258 by U.S. lunchtime, with the FTSE Eurofirst index of euro zone stocks virtually unchanged at 994 — losing its gains after initially shooting up above 1,000.

Markets’ muted response partly reflects the fact that New Democracy’s success still leaves Greece mired in a political morass, which adds to traders’ malaise about the currency union in general.

New Democracy, led by the economist and politician Antonis Samaras, has won only 129 seats out of 300 in the Greek parliament — leaving it well short of an overall majority. Even this incomplete victory has been sullied, since New Democracy responded to Syriza’s initial lead in opinion polls by pledging during the election campaign to attempt to soften the strict bailout terms imposed by the EU and International Monetary Fund. Samaras confirmed after the election result that he would seek “alterations” to the bailout — which includes exacting debt reduction plans that have plunged many Greeks into poverty. EU officials have indicated that they are prepared to concede some changes, but the gap between what the EU and Samaras’ team consider acceptable could be hard to bridge.

To secure an overall majority to enable it to form a government, New Democracy is most likely to ally itself with Pasok, the socialist party that also supports the international bailout — though Pasok toes this line with some reluctance. Even if these cracks are papered over, a coalition based on these two traditional enemies is likely to be unstable, given the deeply ingrained confrontational style of Greek politics.

Jim Reid, credit strategist at Deutsche Bank in London, said that Alexis Tsipras, the head of the antibailout party Syriza, was set to form “a powerful opposition.” He added: “Unless the new coalition (assuming one is formed) can pull together, in spite of diverging views, and can turn around the economy and/or renegotiate their arrangements with Europe, then Tsipras’ surge in popular support may continue and prove to be a rather large shadow over the government and the financial market.”

Pasok had initially said that it would only form a coalition that included Syriza. Tsipras’ decision to reject this overture in favor of keeping Syriza in opposition could give independently minded hard-left factions within the party more freedom to foment civil disobedience — further destabilizing the country.

The prospect of weeks or months of European uncertainty, as Greek politicians wrangle over the formation of a government which then wrangles with the EU over the terms of the country’s bailout, has left analysts scratching their heads over the best investment strategy.

HSBC said that despite New Democracy’s partial victory, “longer-term investors will still be left with macro uncertainty surrounding the pace of EU policy change, the progress of the Greek and Spanish bailouts and the extent of the economic slowdown.” Financial markets are looking to EU politicians and the European Central Bank to prop up the euro zone economy — with Thursday’s index of purchasing managers expected to show a continuing sharp decline in the currency union’s output.

In response, HSBC recommends European stocks that are “relatively resilient to macro shocks” — performing well during both bull and bear markets induced by the euro zone crisis over the past year, because of their upwards revisions in earnings forecasts. These include the global advertising giant WPP and Deutsche Post, the German delivery company.

Many investors have responded to the recent twists and turns of euro zone politics by putting money in safe havens including German Bunds and U.S. Treasuries. The yield on Bunds sank another 7 bps on Monday to finish European trading at 1.40 percent. However, Macro Risk Advisors, the hedge fund advisory firm, has warned that the “huge retrenchment of investors into ‘risk-free’ assets such as German and U.S. bonds” could prove “dangerous.” It explained, “These assets are vastly overvalued and could shock investors should policymakers try to force people back into risky assets”.

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