It is Game (Theory) Over for now-former Greek Finance Minister Yanis Varoufakis, who resigned early Monday. Photo by Chris Ratcliffe/Bloomberg via Getty Images.
Well folks, Sunday will go down in history books … as the day the US Women’s National Team won their third World Cup. Oh, and it was also the day Greek voters rejected the tough bailout conditions proposed by creditors late last month. Headlines seem divided on whether this puts Greece one step closer to the eurozone’s exit, but not much has fundamentally changed. Greece’s future is still a big question mark, the risk of contagion from “Grexit” remains minimal, and Greece remains far too small to rock the global economy or markets. Heck, Grexit could even be bullish, removing the false fear’s weight from investor sentiment and allowing markets to focus on fundamentals.
As the exit polls came in Sunday evening, headlines warned investors to brace for heightened uncertainty and a market bloodbath. Yet outside Greece market reaction was fairly muted Monday. Greek 10-year yields jumped 333 basis points (bps) to 17.66%.[i] Italian and Spanish yields rose just 13 and 10 bps, respectively, to 2.38% and 2.33%.[ii] Portuguese yields rose slightly more—22 basis points—to 3.16%.[iii] The Global X FTSE Greece 20 ETF (a wild-guess proxy for Greek markets, which remain closed) fell nearly -8%.[iv] Eurozone stocks fell -2.2%, which is volatile, but not hugely so—it’s the 40th move at least that big (up or down) in the last 30 months.[v] The S&P 500 dropped just –0.4%.[vi] These minor moves reinforce what we’ve long said—there is almost nothing about Greece or a potential Grexit that markets haven’t already contemplated and discounted.
Polls before the vote were tight, but few are surprised Greece rejected more harsh austerity.[vii] The referendum asked voters a not-so-simple question: “Should the plan of agreement, which was submitted by the European Commission, the European Central Bank and the International Monetary Fund in the Eurogroup of 25.06.2015 and is comprised of two parts that constitute their unified proposal be accepted?” Accompanying the question—and released to voters in advance—were the actual proposals and a mistranslated analysis of Greek debt sustainability. Faced with all this technical jargon and overwhelming complexity—and promised by Prime Minister Alexis Tsipras that voting “no” would get them a better deal—61% of Greeks said “No” to creditors’ terms. The “No” vote’s wide margin was a surprise, but not the “No” itself.
As we noted last week, the referendum had a few issues. Chiefly, it seemed to violate Greece’s constitution, which prohibits public votes on fiscal policy, and it asked voters to opine on a proposal that was no longer on the table. The terms in question expired along with Greece’s bailout on June 30. So Greece basically said a nonbinding “no” to an offer that doesn’t exist anymore—or as Valdis Dombrovskis, European Commission Vice-President put it: “The meaning of this referendum was to send a political signal with the rest of Europe.”
So we’re basically where we were last week: No deal and, for the moment, no ongoing negotiations. Greek banks are still closed and will remain so at least through Thursday. ATM withdrawals remain capped at €60 daily, and people continue lining up to withdraw the daily max, just in case. The ECB declined to increase emergency funding, and it reduced the value of all Greek bonds used as collateral in the eurozone system (in technical terms, it “increased the haircut”), tightening the screws on Greek banks a bit more. Insiders say Greek banks have about €1 billion in cash left. Absent new funding, it won’t last long.
Tsipras is set to deliver a new bailout request to EU leaders at a summit Tuesday evening, and while he told Greek voters he could get a deal within 48 hours, that seems a tall order considering Germany’s rhetoric has toughened. There is also a new wild card, as Finance Minister Yanis Varoufakis—he of the leather jackets, incendiary metaphors and supposed Game Theory expertise—resigned early Monday. As he explained on his blog: “Soon after the announcement of the referendum results, I was made aware of a certain preference by some Eurogroup participants, and assorted ‘partners’, for my… ‘absence’ from its meetings; an idea that the Prime Minister judged to be potentially helpful to him in reaching an agreement.”[viii]
Markets seemed cheered by this news, assuming Varoufakis’ ouster would improve the likelihood of a deal—this, after all, is the man who called the troika’s terms “terrorism” and “fiscal waterboarding” and reportedly nearly came to blows with Jeroen Dijsselbloem, head of the “Eurogroup” of eurozone finance ministers. Varoufakis’ replacement, Euclid Tsakalotos, had already taken over as leader of Greece’s negotiation team (replacing Varoufakis) and seems to get on better with the Eurogroup and IMF’s negotiating team. He also has the full support of all mainstream Greek party leaders, who signed a “unity pact” Monday to show they’re all negotiating in good faith. Though, the outcome remains impossible to handicap.
For Greece, time is of the essence. They must refinance about €2 billion in short-term bills on Friday, and they owe the ECB about €3.5 billion on July 20. Not paying would almost surely cut off banks’ remaining lifelines, as the ECB would face huge pressure to reject Greek bonds as collateral. Greek banks could also collapse before that if the ECB deems them fundamentally insolvent, which would probably force losses on banks’ creditors, including large depositors—much like Cyprus endured in 2013. Unless Greece gets a deal and more emergency funding, it is hard to envision life getting better for the Greek people any time soon.
But coldhearted global markets should remain indifferent, short-term volatility aside. The world economy is about $77 trillion, and assuming 2% growth and 2% inflation, it would take at least $3 trillion in lost output to cause a global recession. Greece’s GDP is about $200 billion, or 0.3% of the world. It is also the size of Detroit, which went bankrupt in 2013—stocks did great that year. Even if Greece’s economy just stopped, contributing a goose egg to the world, China alone is projected to add three Greeces to world GDP this year.
For all times Greece has kicked the can, and for all the many endgames discussed these last five years, markets have always known there were three ultimate outcomes: The eurozone could become a fiscal transfer union (where rich member-states fund poorer states), it could monetize the debt, or Greece could walk. All have been discussed ad infinitum. Markets have been pricing all this in for years—you can see it in Greece’s divergent bond yields, default insurance costs and stock market. Markets clearly expect Greece to have a long, hard road. But they don’t expect that for the rest of Europe, and markets in Spain, Italy and everywhere else are aware of everything that has made Greek markets plunge. Markets simply know Greece is too small and too well-contained to ripple globally—see our analysis here and here for the details.
Sentiment, however, remains depressed, which is why Grexit could be bullish. Getting this over with would be like ripping a Band-Aid off—sometimes it hurts for a second, but then you’re fine, and you wonder why you worried about it. If Greece leaves, and investors see Europe and the world sail through, the world can finally get over this big false fear. That would lift a huge weight from sentiment, allowing folks to move more firmly into optimism—and propelling stocks up the proverbial “wall of worry.”
[i] FactSet, as of 7/6/2015.
[v] Ibid. Percentage change in the Euro Stoxx 50 on 7/6/2015 and frequency of daily percentage change exceeding 2.2% (up or down) from 12/31/2012 – 7/3/2015.
[vi] Ibid. Percentage change in the S&P 500 price index on 7/6/2015.
[viii] Separate reports say Tsipras decided to sack him after Varoufakis told the UK’s Telegraph that Greece was prepared to start paying civil servants and pensioners with IOUs, just like California did in 2009—and all but advocated leaving the euro while hurling a colorful epithet at all other eurozone leaders. Of course, this is all hearsay and sociology, but it underscores the internal divisions in Greece’s government.