It is time to do some scenario gazing on the show. What are the possible outcomes and what should markets be prepared for on Monday morning?
It is time to do some scenario gazing on the show. What are the possible outcomes and what should markets be prepared for on Monday morning? In an interview to CNBC-TV18, Lyn Graham Taylor, fixed income strategist, Rabobank and Jeavon Lolay, director global research, Lloyds talk about the possible result and how markets across the globe are likely to impacted.
Here is an edited transcript of the interview. Also watch the accompanying videos.
Q: What may be going on in the minds of the Greek public as they go to vote? Do you think that as the Greek public votes this Sunday, will they in effect be deciding on whether Greece stays in the Euro zone or exists?
Lolay: It is going to be perceived like that, but that’s not the case because this still is very much an election. It’s the second election and if we are talking about exit for the Euro area, it is not at this time. It may be in the future that we have to have a referendum and this is definitely not referendum. But what we will find out is, what sort of support there is for the Euro area and if it can survive with the current program and still make it through.
So, it’s a very pivotal election, but it is not the make and break on whether Greece will stay in the Euro area or not.
Q: What do you make of the significance of Sunday’s elections, the outcome and possibly what message the Greek public is trying to send out, not just to Europe but to the rest of the world?
Taylor: It obviously provides a strong indicator but I think the way the politicians are spinning this vote to the Greek people are desperate wants to stay within the euro zone. So, its being addressed up in Greece as a vote, both parties want to be voted on the basis that they will stay in the euro zone. So, I don’t think the Greek people when they vote are deciding whether they want to stay in the Euro or not.
Q: Let me now look at three election outcomes that are possible and you tell me how you see global markets and central banks reacting to these outcomes and whether these outcomes will eventually lead to a Greek exit, may be not in the near term, but over the longer term. The first out come, ofcourse, is the one that markets fear the most. If the anti-bailout parties come to power or come to a majority, how do you think that will impact markets, central bank reactions and what do you think that will mean in terms of determining whether over a period of time Greece stays in or leaves?
Lolay: That is the fear point for markets at the moment. If we do get a Syriza victory in the election then what we will find is initial negative market reaction. That’s not the end of it because Syriza was unlikely to get enough votes to secure government on its own. So, it is going to have to negotiate with the other parties to try and put something together which is likely to make it less controversial and probably ease back on some of its demands.
So, the question is not necessarily that its over, if Syriza wins it’s a question of what will the new government look like and how far will they be willing to negotiate. The issue they will face is that, there is unlikely to be another bailout. They will have to work within the realm of the current bailout. We know that the EU is softening a bit in terms of what Greece may receive in the future, but at the same time it is very difficult to see if they want to have a fundamental renegotiation. They won’t be able to get that and if they are adamant to do that then Greece’s position in the euro area is very much under threat.
Q: I imagine that you will categorize this as a complete risk off event.
Taylor: With regards to the market, there is two ways this could go really. You could see a strong bid for bunds and a further selloff in periphery. Or potentially there could be even a selloff in bunds and a move out of Euro denominated fixed income assets into the dollar. This could act as the beginnings of a Greek exit.
Q: The other and the more appetizing potential outcome is that the pro-bailout parties come to power as an outcome of this election. In that case how do you expect markets will react? Do you see any central bank action thereafter at all required considering that they are pro-bailout parties and then do you see the chances of Greece having to leave the euro zone diminish?
Taylor: Quite unlikely that there will be a requirement for central bank action in that case. I think the initial move will be a risk on move as the market is basically pleased that this combination has come in. But then as soon as the coalition is formed the, negotiations begin expect the protracted nature and difficulty of those negotiations to drive a risk off move essentially.
Lolay: Even in the May 6 election, New Democracy did win that election, the problem was that they couldn’t actually form a government. This time around obviously if they do win this election there is more pressure on them and the other parties to actually form a government and therefore that’s obviously positive for the near term.
The concern though has to be that there is still an awful lot that Greece will have to deliver. The amount of reforms, structural reforms, cost cutting required is extremely difficult. You cannot be sure that a victory by new democracy, a new government is a sufficient condition for Greece to remain in the euro area.
So, I think we see some positivity from initial market reaction, but the concerns about what Greece has to do and how difficult it will be for them continuing as concern for markets and probably develop as the weeks and months go ahead and we see what they can and can't do.
Q: The third scenario may be as troubling or worse than the first one and that is there is no clear majority that emerges from Sunday’s elections, in effect we go back to the situation we were in May, nobody is able to form government. What are we then faced with in terms of potential outcomes, in terms of a third reelection, in terms of a technocrat government taking over?
Taylor: Given if something happens, similar result to last time, its view at the moment is more likely to be a technocrat government comes in than simply another round of elections. Probably somewhere in the middle with regards to the chance of central bank action being required markets are probably just a straight risk off move as we really don’t know what technocrat governments would likely to show policies or would likely to enact. Essentially there are 9 days to form a coalition and if no coalition is formed we assume that they will go towards a technocrat government.
Lolay: Unfortunately I think this is probably the most serious outcome. If you are in a situation where we still don’t get a party that’s technically cannot form a government. I certainly think that Greece may not be unable to afford a third election and I don’t think markets may even give it time. That potentially could be the worst outcome. Hence I think this outcome is the least likely out of the three because whoever does win this election.
I think somebody will be under utmost pressure to ensure that they can form a government even for a short time. This third scenario is probably the most vulnerable for markets because we will be unable to last for another month or six weeks for the same sort of uncertainty at a time when you see pressures building all around the euro area for a variety of countries. This is probably the worst outcome for markets.
Q: What do you mean by unable to last out this uncertainty, if there is in fact a split verdict and like in May? None of the parties is able to form a government, what are we going to be faced with both politically from a process point of view and of course from a global reaction point of view?
Lolay: I would say basically if we cannot form a government for at least another month if not more so longer than that then we have to consider is the February bailout even workable. We will probably require a brand new bailout. If we don’t know what is going to happen again, can Greece afford to have a fourth election, there is just far too much uncertainty.
Q: Is there any chance of a third election at all?
Taylor: It cannot be ruled out but I think generally people think it is more likely that given the further uncertainty, which will be good for Greece. The third election would bring what at the moment we think is considered more likely the technocrat government would come in.
Q: To leave the third option aside for a bit and to focus on the first two outcomes that we discussed. Your comments did indicate that you believe whether it is the pro-bailout parties or the anti-bailout parties that come to power in Greece, a renegotiation of the terms of the second bailout is a given. It will take place, it could be less hardlined depending on who the winners of that election are but that there will be a renegotiation.
In that case what do you expect will be the content of the renegotiation assuming it will be a long drawn out renegotiation. What kind of pain do you think that will inflict on global markets? What will it mean for interest rates across the peripheral countries? What will it mean for central banks wanting to step in and help quell the panic? How will that situation go down?
Taylor: So if things are likely to be included in such a package perhaps reduction in interest payments on a restructured debt and also sweetness perhaps with regards to AIB investments in the country so further encourages the growth essentially. The market hates uncertainty and this will create huge amount of uncertainty so you are likely to see further fiscal tight move.
It is a difficult call on central bank action perhaps difficult to see any major co-related central bank action. This is just a general risk-off move headline type trading where perhaps one party negotiation comes out with something positive, classic negotiation position where each side wants to give just enough to get as much as they can.
Q: Given all the noises that Central banks have made in the run up to this election weekend, are you feeling a little more reassured that no matter what the outcome, there will be enough backstopping available? There will be enough political action available if the worst case scenario whatever that maybe were to come to pass?
Lolay: As I said I don’t think the worst case scenario is next week. I think what we are going to get is a message about how difficult the circumstances are in Greece, what we need to do. It is not the worst case scenario, the worst case scenario will happen in the future like I said.
If Greece cannot afford to remain part of the euro area, that is not the case now. I think either party along with this government there will have room to negotiate the actual scale of negotiation will be under consideration. I think a lot of efforts will still be made to keep Greece in the euro area. The issue, is like I said, this continued uncertainty and how long markets will give them time.
Q: What impact will the outcome of this election have on a third round of quantitative easing; the FOMC meets next week or even a third LTRO? Though I do know that ahead of the ECB has been stressing on the fact that the effect of the second round have not yet been fully felt?
Taylor: Personally I cannot see another LTRO. The banks now generally have as much as they need. So it didn’t help bring sovereign yields down in 3-5 months of region so we possibly cannot see another LTRO would have any significant long-term effect or benefit. With regards to the US, it cannot be ruled out but again it is not immediately something we see on the horizon.
Q: Since you have made it clear that it is impossible to look more than 24 hours down the line? What are you preparing for on Monday based on instinctively? What do you think will be the message that the Greek public send out to Europeans and to people across the world, what are you advising your clients to be prepared for as well?
Lolay: I personally am hoping for victory for New Democracy for pro-bailout victory and therefore some positives to come on the back of that. Then what we would hope to see is negotiations begin and therefore Greece probably get an easier time of it that it has had previously.
But in the worst case scenario, we have to be ready for coordinated action and possibly particularly its strong reaction on the banking side and the sovereign side to support some of the weaker sovereigns at this time.
For my clients, I have been particularly advising that basically stay clear, have an open mind to whatever happen. We saw only last week with the Spanish deal a lot of markets were spooked by what happened there when the consensus was that it would have been taken positive, it has been taken very negatively. Markets are not behaving very rationally at this time and that is a concern for everybody in the market place.
Q: What are you telling your clients?
Taylor: We are personally favouring long bond positions so primarily bond flatness. It has been a bit of a quite aggressive sell-off and indeed there was a sell-off in the first LTRO which was the last peak in the market uncertainty. That is the way we are trading this, so long call essentially in the eurozone. I think interesting trigger is a fall in euro dollar because that could mean – the sign that people are moving out of euro assets.