Global Macro Strategy
July 6, 2015
Paul Christopher, CFA®, Head of International Strategy and Co-Head of Real Asset Strategy
Analysis and outlook for the global economy
- Greek voters on July 5 rejected reform requirements from the country’s official creditors, thereby making a deal for new financing unlikely.
- Without a reforms-for-cash deal, Greece probably will default on a scheduled July 20 payment, and thereby lose the main source of cash for its banks.
What it may mean for investors
- We encourage investors to be patient, watch for a Eurozone response to Greece, and resist the urge to trade on Greek headlines, which we believe are largely political and not based on fundamental factors.
Greece Moves Closer to a New Currency
What happened and what it means
On July 5, Greek voters rejected their creditors’ proposed economic reforms, choosing instead to forgo the cash that Athens needs almost immediately. Polls ahead of the referendum suggested that voters would accept the reforms, but the “no” vote prevailed with a three-to-two margin. Exit polling suggested that many voters still want the euro but also want to change intolerable current conditions. In addition, some voters lacked the cash to return to vote in their home villages and islands.
Greece’s choice is stark. If Greece defaults on its July 20 €3.5 billion ($3.9 billion) repayment to the European Central Bank (ECB), ECB rules require canceling the emergency lifeline to the Greek banks. With approximately €139 billion ($153 billion) in deposits but only €2 billion ($2.2 billion) in ready cash (as of May 31 ECB figures), the government almost certainly will keep the banks closed through July 20 and could replace depositor savings with IOUs against future government tax receipts. The value of future Greek tax receipts is likely a shrinking figure, implying that any scrip (provisional currency) could depreciate quickly. Greek residents would soon find themselves with even less food, medicine, and gasoline than today—and at a higher cost in daily wages. In this situation, the euro likely would become the Greeks’ currency for saving, while the scrip would serve for daily expenditures.
France and Germany have called a July 7 summit for heads of state to deliberate a response to Greece, but both Greece and its creditors have made a reforms-for-cash deal more difficult. Both have a strong interest to keep Greece in the Eurozone, and negotiations may resume. Yet, mutual trust has so eroded that cooperation may fail in the short time before July 20. Unless the political obstacles recede, the base case has become parallel currencies in Greece.
What a Greek euro exit means for global financial markets
Government bond yields may rise for peripheral countries including Spain, Portugal, and Italy, while the euro and European equity markets weaken. Faltering global risk appetite also may dent emerging-market financial markets. U.S. equity markets may see some selling as a spillover from European markets, but the strengthening U.S. and European recoveries should blunt the U.S. impact. Meanwhile, the U.S. dollar, Swiss franc, Japanese yen, German Bunds, and U.S. Treasury prices should attract investors looking for perceived safe havens.
Risk aversion globally may be stronger than that which we observed after the June 29 disappointment but we believe is unlikely to repeat the 2010 market correction, when the benchmark Euro Stoxx 50 index lost 17 percent between April 14 and May 25. Five years later, the Eurozone economy is gaining strength and breadth, and our work shows Europe has the top economic momentum outside the U.S. European banks are financially stronger and hold almost no Greek assets. In our opinion, the ECB’s ongoing sovereign-bond-buying program and improving private loan demand should fuel the recovery.
In addition, we believe improved financial conditions and ECB bond buying should keep sovereign bond markets from worries that another Eurozone country exit is imminent. Still, if Germany, France, and other leading countries respond mainly with recriminations but fail to reinforce their financial markets, then the referendum disappointment eventually may undercut confidence and the economy. Conversely, a proactive response in the coming week or two should limit the depth and duration of the initial disappointment. Investors should watch for several possible steps:
- Keep Greece in the wider European Union: Greece's economic step down could create social chaos, a failed state, and possibly a breeding ground for terrorism and anti-Western power. Europe needs to ease the potentially worsening humanitarian crisis and keep Greece connected to the wider European economy.
- An increase in monetary stimulus: The ECB accelerates bond buying under its aggressive monetary stimulus program (also called quantitative easing).
- ECB Reassurances: The ECB assures markets that it will employ additional tools in case of market stress.
What long-term investors should do
Greece and its creditors have greatly complicated the negotiations to keep the euro as Greece’s featured currency. A deal now seems unlikely, but a resolution may yet elude investors for some weeks to come. However, even if a deal ultimately fails, the economic basis for further European equity market improvement should remain, especially if Europe produces proactive policy responses. Our focus for the second half of the year remains on the economic recovery, and to prefer equities over bonds, and U.S. and developed markets over emerging markets. Therefore, for now, we believe investors should be patient, watch for a Eurozone response to Greece, and resist the urge to trade on Greek headlines.
Paul Christopher is the head of international strategy and the co-head of real asset strategy for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.
Mr. Christopher focuses on the international economic outlook and offers investment advice on currencies and commodities. He is frequently quoted in the national media, including The Wall Street Journal, The New York Times, Forbes, Time, Investor's Business Daily, USA Today, Bloomberg News, ABC News, NBC News, and CNBC.
Prior to joining Wells Fargo, he developed economic strategies to trade in global financial and commodity futures markets for Eclipse Capital Management. In previous positions, Mr. Christopher supplied international economic perspectives for Wells Fargo predecessor A.G. Edwards, and advised institutional clients of Istanbul-based Global Securities on the oil-based economies of the Caucasus and Central Asia. He has consulted with the governments of Hong Kong, Egypt, Russia, Kazakhstan, and the Kyrgyz Republic on monetary policy issues.
*As of Sept. 30, 2014
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