After months of wrangling, it seemed Greece and its creditors were close to an agreement last Friday to avoid a Greek debt default. However, tensions increased once again over the weekend, as Greek Prime Minister Alexis Tsipras unexpectedly called for a referendum on July 5th. Since no agreement with the institutions is expected to be validated before the end of June, Greece won’t be able to pay back 1.6 billion euros of International Monetary Fund loans. As a consequence, the ECB has refused to increase the Emergency Liquidity Assistance to the Greek bank sector. Hence the Greek government will keep banks closed until at least July 6th and cash withdrawals will be limited to 60 euros a day.

Candriam has identified different possible scenarios and probabilities, and the consequences for the financial markets:

Greece sticks to its plan to hold a referendum on July 5th (Probability: 95%)

Scenario: Greece and its creditors are unable to find an agreement before the end of this week.
In this scenario, there are two possible options:

A) The Greek government keeps advising its population to vote “no” (probability: 75%)

Scenario 1: Greece votes “yes” (probability: 45%)

This is probably the most likely scenario. The Greek population is now really starting to feel the brunt of the financial and political deadlock, as cash withdrawals are limited to 60 euros. In this context, the Greek population votes “yes”, as they recognise an agreement with Europe is the only way out of this crisis. Recent polls (from the Greek newspaper Proto Thema and from To Vima) already show that the vast majority of Greeks want to stay in the Eurozone.
In this scenario, Tsipras could be forced to resign. If he is, this would open the way to a period of political instability in Greece with doubts on the actual execution of the austerity measures and structural reforms. The eurozone bailout programme would only be extended for a short period of time, which would lead to a temporary relief on the markets (decrease in the equity and bond risk premium). The Greek issue would, however, not be definitely solved.

Scenario 2: Greece votes “no” (probability: 30%)

In the case of a “no” vote, there are two possible options:

  • The Eurozone and ECB do all it takes to avoid contagion (probability: 25%): An exit of Greece from the euro would, in the first place, increase uncertainty, pushing peripheral spreads higher and equity markets down. However, we believe this shock could be limited by a quick and massive reaction of the eurozone. The role of the ECB in limiting contagion would be key. It now has the means to be much more reactive than during past crisis periods. The political reaction should also be strong and lead to greater integration. We, however, recognise that it would take more time to save the European political project. In this case, the impact on our macroeconomic scenario would depend on the depth of the confidence shock, as the direct impact is limited (Greece only contributes around 2% of the Eurozone’s GDP). Market volatility would increase at first with a possible positive reaction to a significant ECB reaction. Our positive bias towards both equities and peripheral bonds over the medium term would depend on the economic impact and the credibility of the ECB action.
  • Grexit without significant euro zone reactions (probability: 5%): Although unlikely, the Euro group might possibly be too timid, demonstrating a lack of the political will to save the European project. Confidence would then be depressed and activity would falter. In this case, volatility would jump, equity markets would face a strong correction, spreads would explode and the future of the euro would become uncertain.

B) The Greek government advises its population to vote “yes” after new negotiations (probability: 20%)

In this case, we believe the Greek population would also vote “yes” (probability: 20%)

Tsipras finally agrees on the terms of a cash-for-reforms deal (probably after a new round of negotiations), realised by last-minute negotiations, and presents the proposition to the Greek population. The Greek population votes “yes” and Greece receives the needed bailout funds to avoid a debt default. This would clearly result in a risk-on mode on the financial markets, with equities rising and peripheral spreads tightening.

An agreement between Greece and Europe by the end of the week and the cancellation of the referendum (Probability: 5%)

Scenario: The best possible scenario is still probably the most unlikely one. The Eurozone has increased pressure on Prime Minister Tsipras by refusing extra emergency funding for Greece after his call for a referendum. That unexpected reaction – putting the blame for the crisis on Tsipras’s shoulders – could open the way for another round of negotiations. In this scenario, negotiations would lead to an agreement between Greece and its creditors before the end of the week.

Consequences: An agreement would probably result in an annulment of the Greek referendum. This scenario would be very bullish for both equity market and peripheral bonds.

 

Conclusion

In our scenarios, the risk of a Greek exit from the Eurozone has not necessarily risen over the past days. We still estimate the probability at 30%, but the probability of a clearer, more positive outcome has decreased. There is now a higher risk of political instability in Greece and a temporary deal should avoid a short-term collapse. Our positive bias towards Eurozone equities will be maintained as long as the current Greek crisis doesn’t materially affect our macroeconomic scenario for 2015 and contagion is limited following a positive Greek vote next Sunday.

 

 

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