November 23, 2012 6:20 pm

Markets unfazed by Greek cliffhanger

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If cliffhangers are needed to keep financial markets on edge, Greece is doing its best to help. A deal on releasing €44bn in long-overdue international aid was shelved this week after eurozone finance ministers fell out again over how to reduce the country’s debt mountain.

Athens, meanwhile, is filling budget holes by issuing four-week treasury bills, a short-term instrument not previously used in the decade since it joined Europe’s monetary union. The scope for an accident that would tip Greece over the precipice looks high.

Greek equities

Greek equities

But were financial markets bothered? Hardly. The FTSE Eurofirst 300 index ended the week up 4 per cent. Greek equities rose 7 per cent. Greek government bonds have also rallied on hopes Athens might try to buy back debt held by private investors.

Rather than sounding the alarm, markets appear confident that eurozone leaders have at least the Greek problem under control. “They are just not looking in that direction,” says Graham Secker, equity analyst at Morgan Stanley. “Markets now have the confidence that, when push comes to shove, European politicians will find a solution. That was not the case a year ago.”

Elsewhere in the eurozone periphery, sentiment has also shown signs of improving, with Spanish and Italian bond yields falling amid confidence that the European Central Bank will act as backstop and signs that the worst of the eurozone recession may be over. “We have put our feet back into the Mediterranean,” says Andrew Bosomworth, Germany-based portfolio manager at Pimco. “We’re not swimming but we have put our feet back.”

Eurozone talks on Greece’s funding needs and its public debt profile over the next decade resume on Monday. The consensus market view is that immediate relief for Greece will not be held up much longer.

“Between now and 2020, anything could happen. So why are we so fixated on something that is going to be affected by so many variables?” says one banker close to the talks. “If there was a prospect of money running out for Greece in the next few months, markets would have something to talk about, but that is not the question for the moment.”

Greece’s finances remain perilous. Greek banks are being propped up by about €100bn in emergency liquidity assistance provided by its central bank, under licence from the ECB in Frankfurt. In turn that has allowed Greek banks to keep buying Treasury bills – last week it sold €3.3bn in four-week bills paying an interest rate of almost 4 per cent – which has then allowed Athens to service Greek government debt owned by the ECB.

However, nobody watching the central bank seriously expects the ECB to break that loop and push Greece into a catastrophic bankruptcy. “The ECB doesn’t want to increase its exposure to Greece, but the country can’t be allowed to default over a tiny T-bill issue,” says a different banker.

Longer term, markets see as inevitable a writedown on international public sector creditors, maybe after Germany’s elections next year. “I’m starting to sympathise with the Greek situation,” admits Pavan Wadhwa, interest rate strategist at JPMorgan. “There is zero probability that Greece can repay its current debt load. Some sort of meaningful haircut simply has to happen.”

Even if Greece avoids disaster scenarios, it is still far from attracting mainstream investors. “Greece is insolvent,” warns Mr Bosomworth at Pimco. “The distressed debt market is a different field – it’s for the sort of people who would be prepared to physically take over luxury yachts in the Aegean if necessary.”

Investors fled Greece as the global economic crisis erupted five years ago, with its share prices falling further after the country’s debt crisis started in late 2009. By the middle of this year, Greek shares were down 85 per cent on their 2007 peak.

But since June, the Greek benchmark Athens General index has risen by 60 per cent, prompting some investors to reconsider the asset class. “The market is priced for the worst-case scenario of a Greek exit from the euro and further, even more extreme distress to the Greek economy,” says Achilles Risvas, managing partner at Dromeus Capital, the emerging markets hedge fund manager which this month launched a Greek-focused fund. “The huge uncertainty and political instability has caused investors to sell down Greek assets to prices from which the likelihood of further declines is limited.”

For much of the past three years, global investors have worried about Greece’s public finances. Still, not everyone is convinced that stability has improved dramatically. Financial markets remain “full of ‘cliff’ or ‘trigger’ risks,” warns Matt King, strategist at Citigroup, who notes investors have this week also shrugged off Moody’s removal of France’s triple A credit rating. “It’s a bit like trying to predict what sparks a forest fire. One, two or three carelessly dropped matches and they burn themselves out harmlessly. But that doesn’t mean a fourth or fifth match can’t burn down an entire forest.”

Additional reporting by Robin Wigglesworth

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