Greece unlikely to exit the euro… soon

In recent weeks, the global financial markets have suffered from contagion from the Greek crisis, as another round of negotiations between Greek Finance Minister Varoufakis, Prime Minister Tsipras and Greece’s creditors collapsed. Both bond and equity markets signalled their alarm that a deal may not be reached by the end of the week, endangering the scheduled Greek debt repayment of 1.6 billion euros to the IMF.

You can find hereby an overview of three possible scenarios and probabilities, and the consequences for the financial markets:

A fully-fledged deal between Greece and Europe (Probability: 10%)

• Scenario: The best possible scenario is probably the most unlikely one. Tsipras stops bluffing and a last-minute agreement between Greece and the euro zone is reached. In this scenario, the bailout programme will develop into a long term recovery plan. Unfortunately, time is against the negotiators and the probability limited.
• Consequences: A fully-fledged deal would be bullish for both equity market and peripheral bonds. Interest rates from the core countries would continue to creep up to be in line with fundamentals and short duration would have to be maintained.

A temporary agreement to buy more time (Probability: 60%)

• Scenario: As the probability on a fully-fledged deal has declined strongly, an intermediate scenario is the most probable outcome. The euro zone would buy more time by temporarily extending Greece’s bailout programme by another couple of months. Prime Minister Tsipras would then have to present the euro zone’s final proposition to the Greek population via a democratic referendum.
• Consequences: This scenario would in the end be rather positive for the financial markets, as we believe the Greek population would vote in favour of Greece staying in the euro zone. As a final solution remains absent in this scenario, volatility would increase. After this more volatile period, equity markets would rebound and peripheral spreads should tighten.

An exit of Greece from the euro (Probability: 30%)

• Scenario: Negotiators fail to reach any kind of agreement and Greece defaults.
• Consequences: In case of a Grexit, there are two possible outcomes:
1. A) After the initial shock, the rest of the euro zone reacts positively (25 % probability)
An exit of Greece from the euro would, in the first place, increase uncertainty, pushing peripheral spreads higher and equity markets down. However, we believe this shock would only be temporary, as long as the euro zone took the situation in hand. The direct impact should remain limited on a mid-term perspective:
• Firstly, the European Central Bank would do everything to avoid a strong interest rate rise in the periphery.
• Secondly, the euro-zone members would likely recognise the fact that their ‘medicine’ for the Greek crisis hadn’t worked. It would encourage the Euro group and its individual members to do all it takes to save the European political project.
In this case, the impact on our macroeconomic scenario would depend on the depth of the confidence shock. Market volatility would increase, though with a positive bias towards both equities and peripheral bonds.
2. B) Grexit without significant Euro zone reactions (5 % probability)
Although unlikely, the Euro group might possibly withhold supportive measure to avoid a new recession due to a confidence shock, and the absence of the political will to save the European project. In this case, volatility would jump, equity markets would face a strong correction, spreads would explode and the euro would become uncertain.