The Franco-German axis ahead of historic decisions for euro zone

Resignation of Greek Finance Minister Yanis Varoufakis indicates that Prime Minister Alexis Tsipras is willing to reach a deal

The Greek people have rejected with a clear no (61 percent) vote the creditor package (as outlined per 25 June), bringing huge uncertainty to the Greek situation and beyond. This is a large success of Greek Prime Minister Alexis Tsipras – a remarkable domestic political win in a situation where Greek banks are running out of cash and pension payments are rationed. The clear outcome makes a solution of the “Gordian knot” more likely than a tight “no” or a tight “yes”. Now the fundamental question is the following one: is the euro zone better off with or without Greece? In some corners of the euro zone, the answer is without Greece, as a dilution of common rules would jeopardise the long-term sustainability of the common currency. In other corners the answer is with Greece, as a “Grexit” would mean the end of the irreversibility of the euro, with unforeseeable consequences. Interestingly, Angela Merkel is clearly against a “Grexit” but at the same time underlines the importance of playing by the rules. In Frankfurt, the European Central Bank (ECB) will have to make an ominous decision: maintain the current emergency financing at around 90 billion euros or reduce it. Actually, without a clear path toward the restart of negotiations, the ECB would have to reduce the financing, meaning the indefinite closure of Greek banks. An emergency summit of the members of the European Monetary Union has been called for Tuesday night to assess the new situation.

What is the olive branch? If there is one point which makes economic sense and where the Greek ruling party Syriza and the International Monetary Fund (IMF) share the same view, it is debt relief, i.e. the restructuring of the Greek debt. True economic reforms against debt relief (reduction of around 30 percent?) looks like the only path left to “cut” the Greek Gordian knot. However, the ability of euro-zone leaders to grant debt relief at this juncture goes against the vested interests of the ruling conservative parties in Portugal and Spain, which will face parliamentary elections this fall. Even though the Greek prime minister has gained credibility, he has a strong interest to strike a deal quickly as the current Emergency Liquidity Assistance (ELA) allows only for a couple of days of daily withdrawals of some 60 euros per Greek account holder. Time is running against Tsipras as the economy is seizing up and delaying negotiations would quickly erode his domestic political goodwill. At the same time, many euro-zone politicians seem to have lost trust in Tsipras’ government as a reliable partner. Meanwhile, the resignation of Greek Finance Minister Yanis Varoufakis indicates that Prime Minister Tsipras is willing to reach a deal.
That being said, we still believe that the Greek crisis is broadly irrelevant for the direction of global markets, for the reasons we have already mentioned on many occasions:

1. The exposure of western banks to Greece is negligible.
2. Some 80 percent of Greek debt is held by public creditors (euro-zone governments – bilaterally and via the European Financial Stability Fund (EFSF) –, the ECB and the IMF)
3. The macroeconomic picture in Ireland, Spain, Portugal and even Italy has turned for the better.
4. The ECB has the means and the resolve to contain any contagion effect on the “periphery” countries of the euro zone.
5. The Greek crisis is in a way the slowest and best-forecast default in history (contrary to sudden events such as Argentina 2001, Russia 1998 or Lehman 2008), which means that investors have already to a large extent priced in such an outcome.

In addition, the global environment, which is characterised by a recovery across the US, Japan and the euro zone, plentiful liquidity and reasonably strong earnings, remains highly supportive for risky assets.

Christophe Bernard – Chief Strategist – Vontobel