This weekend is setting up to be pretty dramatic as the Greeks return to the polls to try and produce a government. Recall during the first week of May, the Greeks held elections that failed to produce a government and has thus lead to the latest market fears over Greece and the Eurozone as a whole.
The fine folks at UBS are out with a research note today with ten frequently asked questions about the Greek elections. Below are the questions and my answers.
1) Who’s winning?
No one. According to two different polls from the first week of June its almost dead even. New Democracy has a slight lead (26%) over Syriza (23%) and Pasok (9%) is taking up the rear. The important thing to know: 75% of Greeks want to remain on the Euro. Don’t expect a radical change in government.
2) Is the election a vote on Greece’s euro membership?
No. All three parties are saying they will not leave the euro. However, they are telling voters they plan to renegotiate the memorandum or understanding with troika.
3) Can Greece be out of the Eurozone as early as next week?
Yes, but this is a black swan event. Here’s what happens: Syriza must win the election, then its leader Mr. Tsipras must refuse to honor external debt and then it declares total default.
4) Will the election remove uncertainty about Greece?
What’s your best guess? Has anything Europe has done over the past three years “removed uncertainty?” Short-term performance aside an election won’t solve Greece’s problems.
5) What is the ideal election result-from an investment perspective?
It’s hard to say. Its possible that whatever party wins will likely try to renegotiate the MOU. This could spoke the markets into a sell off.
6) Will they [EU, ECB, IMF] pull the plug?
This is highly unlikely. If any of those organizations wanted Greece out of the euro, it would be gone by now. Stay rational.
7) Can Greece survive once its primary balance is zero?
The thought by many pundits here is that if Greece votes an anti-troika government, it will default on all debt and leave the euro. If it defaults, it will be no big deal because its government budget without interesting (aka Primary budget) will drop to zero.
8) Would Greece be better off without the euro?
Most likely yes. Economists argue that a weak currency will make Greek exports more competitive. However, the biggest drawback is Greece cost for imports on energy and food will go up.
9) What if there is another post-election deadlock?
With polls so close, this a likely scenario. According to UBS, if no government is formed by June 26th there will most likely be a national unity government that is supported by all three major parties.
10) What’s the medium-term perspective?
Greece’s euro membership will still be a speculation of uncertainty.
To conclude, Sunday’s election results and its aftermath is a toss up. Anyone claiming to have knowledge about the outcome is blowing smoke up your ass.
Ill have two predictions. The first is I think whoever is elected will try to renegotiate the MOU. Second, I think Greece will eventually exit the Eurozone. Getting the timing right will be the hard part.
Ireland, Portugal, Greece, Spain, Cyprus have all need some sort of bailout from the European Central Bank and Germany. The next country requiring a bailout will be Italy.
According to Bloomberg Briefs, Italy will surpass the IMF’s definition of solvency once the average cost of its debt surpasses 680 basis points. Currently the Italian 7-year sovereign yield has increased from 538 basis points to 589 basis points.
If Italian yields keep moving like they’ve been, the country will require a bailout.
The reason being is simple: spiking funding costs will make the liabilities of Italy start to look like Greece. Italy already has debt as large as Spain and it could become worse with the path its economy is currently on.
The latest IMF predictions for the Italian economy call for a contraction at a rate of 1.9 percent for 2012. I find this incredibly optimistic considering Output declined 0.8 percent QoQ during the first quarter of the year.
Moreover, PMI data in Italy has been getting worse: January 46.8, February 47.8,
March 47.9, April 43.8, May 44.8. I would venture to guess that June’s reading would come in below 43. These readings suggest that Q2 Output will be far worse than Q1.
Finally, the research of Carmen Reinhart and Kenneth Rogoff shows that when sovereign debt surpasses 90% economic growth becomes hindered. Currently Italy’s Debt/GDP ratio is at 126 percent.
If yields continue to rise at the current pace, Italy has less than one month.
“España no es Uganda.”
Translated in English, the statement says, “Spain is not Uganda.” According to El Mundo Spanish Prime Minister Mariano Rajoy sent that text message to European leaders just hours before the now Spanish bailout went down.
Spain is certainly not Uganda but it is Greece and it will no be the last European country that requires a bailout.
On Sunday evening there is still speculative information about the details of the 100 billion Euro bailout. What we do know is: there will be no condition on fiscal policy or structural reforms and the loan will sit on Spain’s balance sheet. This brings up an interesting push/pull; the loan needs to be big enough to convince the market the Spain’s banking issue is addressed while not being so large to jeopardize Spain’s public debt.
This bailout looks like a much bigger version of TARP. As TARP was 5% of US GDP while this bailout is 10% of Spanish GDP.
Below are the main questions:
1) Where will the money come from?
The cash will from the ESM and/or EFSF. Which leads to the main worry: does the EFSF have enough cash to cover the bailout costs? The world’s largest hedge fund, Bridgewater, believes that once it’s time to bailout Italy its game over.
2) Where does the money go?
The bailout cash will go to the FROB, also known as Fund for Orderly Bank Restructuring. Which is a fund-to-fund insolvent banks. It would seem that the FROB looks like a weaker version of the FDIC.
3) What happens to Spanish sovereign debt?
Spanish bondholders are basically getting their first taste of subordination. After watching what happened to holders of Greek Government Bonds, holders of Spanish debt should run for cover. For more on subordination check out this excellent piece by Zero Hedge.
4) What does this mean for Europe?
This is a giant step for Europe as it is now clear that the bad risks will make there way to the public sector. Moreover, it looks like European officials may have bought a little time. How much time? I’m not sure, maybe a few hours, maybe a month or two.
During the next few weeks keep a close eye on Spanish sovereign bonds because once the short-term painkillers wear off, the market will understand another bailout is most likely needed.
Lastly, the next euro-nation to watch is Italy, as it will require a bailout next. As for the next big European event, the Greek election next week should rile the markets.
- Eurogroup Statement
- FROB FAQhttp://www.scribd.com/embeds/96543288/content?start_page=1&view_mode=list