Yesterday, I ended my analysis writing that, “there is enough flexibility in this deal that both sides can declare victory”, and that “from a market perspective, I expect risk-on mood to re-assert itself now. And with the tailwind of lower oil prices, that is supportive of equities and the lower rated sovereign debt in the eurozone.” So far, this is proving to be the case on both fronts. But the real hurdle that lies ahead is the reform list, acceptance of that list and implementation of those reforms.
First, on the market outcomes, we are seeing periphery yields plummet. For example, Portuguese sovereign 10-year yields were trading earlier today at 2.01%, lower than the U.S. level for the first time since 2007. Jonathan Ferro at Bloomberg had a good chart on this earlier today. Click on the link to see the US versus Portuguese yield comparison.
US 10-yr Vs Portugal. What a strange world this is. pic.twitter.com/4oicYlr0At
— Jonathan Ferro (@FerroTV) February 23, 2015
Clearly, the best comparison is the spread to German bunds yields, which are now well under 200 basis points. A year ago that spread was over 250 basis points. I believe the Greek deal favours sovereign yield convergence (toward zero) and riskier assets. Moreover, as I expect GDP numbers to be revised upward in Europe, I also believe that European shares will benefit as well.
The question then becomes how well Greece does in suggesting and implementing a reform agenda that is pro-growth so that Europe can proceed forward without crisis. Moreover, to the degree that Greece gets forbearance on targets, this will help in terms of the growth-over-targets battle elsewhere in Europe, and this is also beneficila to the European economy in my view.
On the substance of the actual Greek plan, a couple of recent articles stand out. First is one in Fortune Magazine about James Galbraith, a colleague of Greek finance minister Varoufakis at University of Texas-Austin. What he said regarding the politics is instructive – and my tweet of the article got a retweet from Yanis Varoufakis, suggesting he supports the substance of the article:
Here’s what I would highlight:
At the Eurogroup conclave, Pierre Moscovici, the EU commissioner for economic and financial affairs, presented Varoufakis with a draft communiqué that allowed Greece to apply for an extension of its loan agreement while granting time to discuss a new growth program for Greece. As Varoufakis stated at the press conference after the meeting, he was poised to sign the Moscovici communiqué, which he praised as a “splendid document” and a “genuine breakthrough.”
But the chief of the Eurogroup, Jeroen Dijsselbloem, was working on his own document. “Yanis said, ‘I have a text,’ and Dijesselbloem said, ‘No, this is the text.’”
Galbraith and the Greek team then attempted to combine portions of the two drafts into a document acceptable to both sides. “My day from that point, along with some other people, was taken up with trying to turn either of those texts into something that could be signed. In another half hour, we could have done it.”
Then, according to Galbraith, German finance minister Wolfgang Schaeuble closed the meeting. “He was saying ‘no’” to fashioning a joint statement as a prelude to a compromise, says Galbraith.
For Galbraith, the lack of coordination on the European side was shocking. “I’m an old Congressional staffer,” he says. “To watch an official body function in this slipshod and ad hoc way, to watch the Eurogroup and the way things were done, was really a revelation.”
The clear implication, as Galbraith put it, was that “the IMF, European Community, and ECB—have been constructive… the finance ministers… are divided and hostile.” Going forward, I believe the institutions will do the heavy lifting on the Greek situation, which, from this analysis at least, is comforting because it means more constructive work and less political wrangling based on differing domestic political agendas. So I am hopeful that we are seeing a situation in which genuine existential crisis is diminishing. I still believe Grexit will occur eventually. It will just not be during a crisis but after a hard slog without economic gains. But that is a speculative view.
Later today on the TV show I produce, the host Erin Ade will be interviewing Galbraith to get his take on the Fortune article. If he says that changes my view here, I will post that tomorrow.
The second analysis I saw that bears pointing out, came from the German Norbert Häring. His posts after the 16 Feb meeting and after the 20 Feb preliminary agreement were very good in understanding the German view and what actually occurred in terms of negotiating outcomes. A lot of what you get in the media is just spin that is based on pre-conceived views. Häring was able to do a fairly good paragraph by paragraph analysis of what Varoufakis presented on 11 Feb and 16 Feb and what was agreed on 20 Feb.
The links are here and here. I would highlight these points:
My view here then is that most of the concessions the Greeks made came prior to 11 Feb and most of the concessions the Eurogroup made came after 11 Feb. Given what we know from Galbraith about the discussions, then, it is clear that there was significant political wrangling. But it did not significantly alter the agreement as proposed by Varoufakis, ostensibly because of the EC, ECB and IMF officials. That said, I expect the Troika reform review to pull back some of the perceived gains for Greece that Häring points to.
In my view, the Häring analysis says we are going to see deficit flexibility coming out of Europe in 2015. It is also further demonstration that we have much to gain from Troika oversight as opposed to Eurogroup decision-making. And that is supportive of risk-on. That said, I do expect the Troika to reject Greece’s reform proposal and for there to be iterations before we lock down an agreement. But we will get there eventually. That’s my base case.
With QE from the ECB lowering the euro’s exchange rate, I am positive about European assets. And note that Q1 2015 GDP and Q1 earnings in the US will be negatively impacted by weather, making Europe on a relative value basis also attractive.