What the Greek Debt Crisis Means for Investors The possibility of a Greek exit from the Eurozone should drive volatility in the coming weeks.
Fidelity Viewpoints – June 30, 2015
Investment markets around the world have grown increasingly volatile recently as Greece has, thus far, failed to secure help to pay its national debt, raising questions about the future of the eurozone, the health of European banks, and what the crisis could mean globally.
The Greek government has been negotiating a new agreement that would deliver financial assistance to help the country pay its debts in exchange for fiscal and structural reforms, but has not reached an agreement with the International Monetary Fund (IMF), European Commission (EC), and European Central Banks (ECB)—known as the Troika. The Greek government has called for a national vote on Sunday, July 5, encouraging Greek voters to reject the “Troika’s” proposal, while closing the nation’s banks and implemented capital controls.
There is still a chance that the government could call off the vote and strike a last-minute deal. But if the election takes place, and the Greeks vote “no” and choose to reject the offer, they will likely default and it could potentially lead to an exit from the eurozone—an unprecedented step with no clear rules. If they vote yes, it is unclear if the current government would stay in power to implement the reforms.
“Regardless of how the vote turns out, this has become a less predictable situation,” says Dirk Hofschire, CFA, senior vice president of Asset Allocation Research at Fidelity. “So it has become a volatility issue.”
No one knows exactly what will happen, but long-term investors should try to keep things in perspective. Here are some insights from Fidelity experts. Three key questions:
Jurrien Timmer, director of global macro
Positive economic trajectory largely intact: Dirk Hofschire, senior vice president of Asset Allocation Research
- Will Greece leave the eurozone? I think this remains a low probability scenario. No one wants Greece to leave the eurozone: Not the majority of Greek politicians, not the Germans, and according to one recent survey, not the Greek people.1 I think that eventually cooler heads will prevail.
- Could a default in Greece cause ripple effects? The big question investors have to face is if the events in Greece could be systemic—meaning could a default or Greek exit from the eurozone cause a crisis in the global banking system or impact the fundamentals in Europe or the U.S.? Even with increasing uncertainty about the direction of Greece, I think the answer is no. When this problem flared up in 2011 and 2012, the risk was systemic because banking systems and sovereign governments in Europe were already on shaky ground in the wake of the financial crisis. At that time many banks and sovereigns were dealing with bad assets on their balance sheets. European banks, private sector investors, and pensions owned Greek debt, and would have taken losses in the event of a default, which could have added to the stress and led to a financial crisis. But since 2012, more than 80% of Greece’s sovereign debt has been moved to the IMF, ECB, and Europe's first bailout fund, the European Financial Stability Fund. So even in the event of default, banks won’t take losses and capital ratios will not be impacted directly by Greece, allowing banks to keep lending. The other important removal of systemic risk is the ECB’s bond buying program and emergency liquidity assistance available to European banks. This greatly reduces the risk of contagion to other peripheral European countries.
- What should investors keep in mind? Ultimately, the uncertainty regarding Greece could drag out for weeks and that could create volatility in the bond, stock, and currency markets. But there are important firewalls in place to limit the impact of events in Greece from spreading to other markets. So it is important to take the long view here and avoid being whipsawed by short-term events.
The clock is ticking for Greece. Banks are closed, capital controls are in place, and its economy is grinding to a halt. According to what the Greek government has suggested, the July 5 referendum will determine if the Greek people vote to accept the reform terms of assistance and reopen a path of economic healing, or make a break that will move Greece closer to leaving the eurozone.
Whatever the result of the referendum, short-term uncertainty won’t disappear. If the vote is “no,” it will be widely interpreted as a vote to leave the eurozone, which would open up an exit for which there is no well-defined procedure. A yes vote also creates uncertainty. Which Greek leaders will go back to the leaders of Europe and say they will implement the reforms that the Troika have requested? The creditors will want to see someone committed to putting the reforms in place, and it’s possible there will be pressure for Greece to call government elections.
The big picture: Unless Greek leaders drop the referendum idea and return to the negotiating table, it is very unlikely that this is going to be resolved quickly and cleanly. That means we are in a period of uncertainty that may not clear up for weeks.
The good news is this may have a much more limited impact on Europe and global financial markets than it might have three or five years ago. The impact of a default now should be more limited, the ECB has liquidity programs and other tools available to help soothe markets during this period of tumult, and the eurozone economy is much better now than at any point since the financial crisis.
During a similar crisis a few years ago, yields on 10-year sovereign bonds in the periphery of Europe rose above 7% in Spain, Italy, and Portugal. Today those bonds have yields around or below 3%, and they haven’t spiked up even as Greece’s bond yields have risen dramatically. That shows you investors have much more confidence in the ECB and policymakers, the improved economic position of Europe, and the more limited exposure of Europe to Greek bonds, loans, and other assets. So there is much less risk of contagion.
The bad news is that this crisis has introduced a huge amount of uncertainty—just as Europe’s economy has gained significant traction. Even Greece leaving the eurozone would not be devastating, and doesn’t mean another European financial crisis, but volatility and uncertainty can bleed back into business confidence and could stall some of the economic progress we expected. The riskier areas of the asset markets such as stocks are clearly getting hit near-term due to increased investor uncertainty. Still, I feel confident that the European business cycle can eventually get better and provide a reasonably attractive backdrop for investors over the next 12-18 months.
In the U.S., the economic outlook is even less dependent on the outcome in Greece. The biggest and best performing part of the U.S. economy is the domestic side, which is benefiting from improvements in employment and a healthier consumer. If you think about the parts of the U.S. economy that are not doing as well—exports, manufacturing, investments in energy, and multinationals—all are being held back by the stronger dollar and weak global growth. So, Greece is a complicating factor to a global environment that was already not helpful to the U.S., and it is consistent with our expectation that investors should expect more volatility as the year goes along. But Greece should not change the overall outlook for the U.S., which I still believe should continue to be in a mid-cycle expansion, which favors risk assets, including stocks.