[GRD] Greece: regime change still the objective
Greece - our analysis so far
As we noted in our strategic outlook in our IDEAFirst product on June 18, 'the real agenda from Europe is to wait Greece out until there is a regime change to a Greek government that is sufficiently palatable to allow a proper funding line.' As negotiations between the Greek government and creditors have continued and broken down, the lack of real concessions from the creditors does suggest the EU don't really want a deal with this Greek regime and are rather seeking a change of government. This view is supported by such comments as Schaeuble's today after the latest (much more reasonable) Greek proposal, saying 'Greece has provided no basis for talking about any serious measures to break the deadlock. From a legal and a real-world point of view, we can't just move forward based on the status quo. We're in a completely new situation now that Greece's second aid program has expired'
The timeline we envisaged in the Jun 18 outlook has essentially come to pass. As we predicted then:
'No financial deal is likely unless the Greek government is prepared to accept the principle of conditional funding. If the Greek government is not prepared to accept this, the EU Heads of State are intent on holding firm and waiting it out until there is a change in government to one that is in accordance with the fundamental principals with which peripheral Europe would feel comfortable, in view of the need to ensure no momentum for a populist swing in their countries.'
'The present Greek government imposes capital controls -- in response to huge capital flight that is already taking place this week, at 500m to 1 billion euros a day, and Bank holidays are announced.'
In our initial strategic piece on June 16, we had already indicated that the market was underestimating the risks in the situation and recommended hedging of risk positions.
'In summary, we believe the reality of the dynamics on the Greek risks are heavily underestimated and recommend risk adjustments and volatility hedges as we enter a politically-driven phase of considerable complexity given a Greek position which is at present unable to accept conditional funding.'
Our expectation of the subsequent events was as follows:
'In the expected phase of subsequent panic and domestic systematic breakdown, a new Greek government is formed which allows an acceptable basis for a deal."
Outcome: The German Chancellor avoids Greek default/exit, keeps core European principles intact, and keeps peripheral Europe happy with core principles adhered to.
Under this scenario, the markets will likely de-risk further before a final deal is struck, when a squeeze can be expected.'
Our current view
The referendum call from Tsipras has obviously complicated matters somewhat, but it hasn't changed the underlying dynamics of the situation.
1. The odds of yes vote will be fluid. The only poll so far available - a ProRata poll conducted on June 28-29 - recorded a 54% vote for a 'no' with 33% for a 'yes', but the second half of the poll - which was conducted after capital controls had been imposed - showed a significantly reduced majority for the 'no' vote. It is likely to be a close call (if it goes ahead as planned), affected both by the impact of capital controls and the various offers and counteroffers made by Greece and the Eurogroup in the meantime.
2. Post referendum elections are likely in August on a yes vote. Initially, after Tsipras resigns, there is likely to be a technocratic government, but the outcome after the elections is unclear. Currently, polls suggest Syriza would still be the largest party, but any new coalition or new leadership, even if it is led by Syriza, is likely to be one that "Europe can work with".
3. A "no" vote is the first step on the road to Grexit. However, it could take some time. It is hard to see how Greece will be able to survive within the Eurozone if the ECB, as seems inevitable in the event of a 'no', cuts off ELA to the banks after Greece fails to redeem bonds held by the ECB on July 20. But the repercussions of a 'no' vote may be such that in the end, concessions are made that allow Greece to stay in the Eurozone, though once again this would have to be under a different government.
The latest proposal from Greece for a third bailout which accepts more of the conditionality attached to the final release of funds from the second bailout will be considered at 5:30pm local time in Brussels today. However, responses so far suggest the EU are in no mood to consider it, with Merkel indicating Germany will wait for the referendum. Tsipras' objective in proposing it may in any case have been as much to influence the result of the referendum as to secure a deal. However, Tsipras and Syriza are no longer making controlled decisions so it is probably wrong to assume they have a clear plan.
So far the market responses to the Greek events have been comparatively muted. European equities are around 3% below Friday's closing levels, but the EuroStoxx 50 index has not yet broken the lows seen in mid-June. We would continue to expect a further sharp equity decline of around 7% from current levels if Grexit becomes the market's central view. We would also continue to expect a further 20bp decline in bund yields in that case.
The EUR/USD picture is slightly more complex because of the EUR's status as the preferred funding currency. While the EUR has tended to suffer knee-jerk negative reactions to Grexit fears, it has tended to recover in response to equity weakness. Similarly, positive Greek news has often seen the subsequent positive equity reaction push the EUR lower. Nevertheless, we still anticipate that greater certainty of Grexit would trigger a more intuitive macro reaction in the EUR as fund managers can be expected to respond by reducing weightings in European equity markets, in which they are currently fully invested. Conversely, any risk-positive outcome is unlikely to provide EUR support for long as the EUR's funding currency status can be expected to reassert itself.