The The January 22nd decision of the European Central Bank (ECB) to supplement its program for energetically accelerating credit growth in the European Monetary Union (EMU) via an extension of its bond purchases from public and private asset-backed and covered debt to investment-grade sovereign and agency issuance of euro bloc members may have been widely anticipated and warmly welcomed by the markets.
Still, the timing of the action appeared intent on attenuating any adverse market reaction to the generally expected outcome of the January 25th national election in Greece. Euro-land equities, in fetching 3.5 percent
cumulatively so far this year (as measured by MSCI’s Eurozone index), are exhibiting a modicum of resilience in spite of the softening pace of advance in their euro-denominated total return (2.9 percent) since the ECB’s move a fortnight ago and the triumph of the populist left-wing, anti-austerity Syriza party in Greek nationwide elections eleven days ago.
The flipside of the EMU’s inexplicably firm stock market performance for the year thus far, though, is still the irrepressible flight to quality fueling credit market volatility, the principal beneficiaries of which remain the most cherished safe havens – US Treasuries and UK gilts as well as Swiss Confederation and Japanese sovereign bonds. While investors seem cautiously patient in awaiting the first official round in a series of talks between representatives of the newly elected regime in Athens and the ostensibly intransigent hardliners in Brussels, the prevailing tranquility should prove short-lived, especially in view of the most recent comments from officials of the Bundesbank and the government in Berlin.
Although some lawmakers of the center-right regime of German Chancellor Angela Merkel had signaled some measure of compromise ahead of the January 25th vote in Greece, Athens insistence on an outright write-down of the of the nation’s debt level elicited warnings from Bundesbank board member Joachim Nagel and German Finance Minister Wolfgang Schaeuble.
Nagel advised Athens of the dismal consequences Greek banks would encounter in the event it were to dispute the conditions of the nation’s aid program. Shaeuble, meantime, ruled out any discussion of a much anticipated demand from Greece to reduce the level of its obligations. He reminded the incoming Prime Minister, Alexis Tsipras, and his recently appointed Finance Minister, Yanis Varoufakis, during a private meeting with the latter in Berlin that Athens will not confront any strains in its public finances insofar as Greece has access to five-year, interest-free loans. An aide to Merkel also cautioned Greece not to repudiate any hitherto negotiated commitments.
With a new Greek ruling coalition comprised of Tsipras’ Syriza party and the far-right Independent Greeks now in place, the first test of its credibility and determination came last Friday when Dutch Finance Minister and chair of the Eurogroup of EMU finance ministers, Jeroen Djisselbloem, flew to Athens to ascertain whether or not the new government was ready to resume a long overdue progress appraisal that, if no insurmountable obstacles were to emerge, could free €7 billion in additional financial assistance to Greece. Yet, the politically inexperienced government appeared in an uncompromising mood and dismissed any discussions with the Troika, which left Djisselbloem no choice but to echo Schaeuble’s reminder and set the stage for highly intense negotiations between Brussels and Athens in the period immediately ahead.
Obstinacy on both sides will probably persist even though Tsipras’ regime dropped its demand for forgiveness of a portion of Greece’s debt. Brussels’ concession to a Greek write-down request seems highly unlikely since, if it were to do so, it would encourage other peripheral Eurozone members to apply for debt reductions, which would set in motion enough moral hazard to unravel the disciplinary regimen guiding the operation of the single currency project since its inception in January 1999. In the end, though, chances of a final deal would improve should Athens and Brussels agree on easier debt financing arrangements for the former that would enable it to continue servicing its obligations and avoid the financial fall-out entailed by an acrimonious withdrawal from the currency bloc, allowing Greece to remain a member of and proceed to benefit from its membership in the EMU.
In the interim, nevertheless, Global Markets Intelligence (GMI) expects the sell-off in long-dated Greek fixed income markets to proceed apace ahead of protracted discussions that, in our opinion, will likely address some form of a restructuring of the nation’s debt. The February 4th decision of the ECB to adhere to its self-imposed rules on collateral eligibility and suspend normal refinancing to Greek banks aims to exert the utmost pressure on Athens and Brussels to come to terms by the end of this month. In so doing, irrespective of all the posturing on both sides of the negotiations, Greek ten-year yield spreads to those of German bunds of the same maturity – after having expanding to 1,087 basis points (bps) by the of last week – have contracted to 941 basis points of late. The weeks immediately ahead promise further seesawing in Greek minus German yield differentials.
Greece’s economic and financial misfortunes aside, more generous than forecast credit relaxation by the ECB (€60 billion a month through September 2016 and maybe longer to re-establish euro bloc price pressures on a sustainable accelerating course) should push investment-grade euro currency bloc yields further into negative territory and establish the basis for a modest uptick in Euro-land economic activity later this year. With ECB – as well as other Western European central banks’ – policy having shifted from managing short-term interest rates to unrestricted negative levels from a zero lower boundary, the euro is likely to remain on a depreciating path for some time to come.
German industry should be the major beneficiary of euro weakness, evident in the DAX’s strong 4.8 percent year-to-date performance in US dollar terms. We reiterate our recommendation of retaining an over-weight of German shares (especially those in the industrial and pharmaceutical sectors) in global portfolios.
Economic momentum in the euro currency bloc, meanwhile, is forecast to remain quite torpid in the first half of the year before accelerating fractionally during the final six months of 2015. Lethargic household consumption, along with tepid public demand and depressed fixed capital formation, will proceed to overwhelm a rebound in exports to hold down real GDP growth through the second quarter.
Afterwards, we anticipate foreign demand to strengthen export growth and gradually re-energize capital spending by businesses, which – in the process – should galvanize the EMU’s rate of expansion only marginally because of the persistent dampening influence of fiscal austerity and dormant consumer demand.
MSCI’s composite euro bloc equity market index is trading at a one-year, forward price/earnings multiple (p/e) of 15.2x, which is comparatively inexpensive vis-à-vis its historical average (16.5x) and fairly priced to its bellwether (S&P Global BMI). Furthermore, EMU shares are relatively less expensive than any of the dollar bloc markets. Thus, is it time to increase exposures to the Eurozone stock market? In GMI’s view, enlarging holdings of Euro-land shares (except Germany) would be entirely premature. Convincing justifications for doing so are in short supply considering the currency bloc’s unimpressive economic outlook. Politically, the tone and duration of the upcoming talks between policymakers representing Athens and Brussels may give an indication of when investors might expect a resolution of Greek-EU differences on what available measures can be taken to ease Greece’s debt burden in the wake of Syriza’s victory in Greek national elections less than two weeks ago.