Greece gets a deal

The unexpected news of the day is that Greece managed to secure a bailout worth between EUR 86-87bn over three years, according to Germany’s Angela Merkel, which must mean that it is true. After failed Eurogroup talks on Saturday, rumours that the EU leaders summit was cancelled on Sunday proved to be false, and it ended up Merkel, Hollande and Greek PM Tsipras thrashing out a deal in all-night emergency talks.

The details of the deal so far include:

• Agreement was unanimous among Eurozone leaders, apparently…
• The establishment of a Greek Asset Fund to recapitalise Greek banks.
• Assets worth EUR 50 bn to be ring –fenced, half to recapitalise the banks, EUR 12.5bn will be used to reduce the country’s debt – to – GDP ratio, while EUR 12.5bn will be spent on economic stimulus within Greece.
• Merkel continues to rule out haircuts on Greece’s debt.
• There will be some bridge financing available to Greece so that it can meet its EUR 3.5bn payment due to the ECB on 20^th July. This will be discussed by the Eurogroup this afternoon.
• Although there will be no haircuts, Merkel has promised to extend grace periods and maturities of Greek debt, which should help Greece to avoid another default in the near term.

Although this saves Greece from the brink of disaster, the European creditors have extracted their pound of flesh from Athens, and there will be no more ESM funds unless we see the “prior actions” implemented by July 15^th (Wednesday). These include changes to the Greek statistical office and VAT guidelines. Merkel, who was talking earlier, made clear what Greece now has to:

• Vote on the reform package, which also includes a complete overhaul of the pensions system, overhauls of the product system, changes in privatisations, and changes in the labour market.
• Vote on the third bailout package.
• Only when Greece has agreed to the reforms will the German Bundestag hold an extraordinary vote to seal the deal to release new funds for Greece.

Overall, the political stalemate has finally ended. It looks like Grexit has been averted, for now. But the Greek Parliament could still scupper the deal by failing to implement the reform package by July 15^th, a tough ask for any Parliament, let alone Greece.

Is Greece really out of the woods?

This “breakthrough” essentially kicks the can down the road for another three years, probably until Germany’s Merkel is about to leave office, leaving her successor to deal with the issue of haircuts for Greek debt. Nothing, so far, has been done to make Greece’s debt load more sustainable, the EUR 12.5 bn from the Greek Asset Fund to pay down debt, is unlikely to be enough to put much of a dent in the 175% debt-to-GDP ratio. However, while we think that this is likely to rise in the coming months and years, the fact that funds have been set aside to shore up the banking sector, avoiding its imminent collapse, makes the prospect of future growth a possibility, so the debt-to-GDP could fall organically in the coming years.

Greece has a few more hoops to jump through before it gets more bailout funds, not all of Europe is happy with the deal, including the Netherlands, however, this is the closest thing to a deal that Greece has seen in some time.

The market reaction:

FX: the euro initially rallied on a deal, before falling back to fresh lows of the day. This decline does not signal that the markets believe the deal is a failure before it has even been finalised, but it could be a sign of risk on for financial markets. For the last 12 months, the EUR has been a funding currency of choice, as the ECB has pledged low interest rates for the long-term and embarked on QE. Now that the uncertainty around Greece has been, hopefully, eradicated, the market may choose to return to higher risk FX strategies like the carry trade, which could put further downward pressure on the single currency. The yen, another popular funding currency, has also fallen this morning, which adds to our view that carry could be back. Ultimately this could be good news for the USD and GBP, where central banks look like they may hike interest rates at some stage in the coming months.

Stocks: as we have mentioned before, as the German spread vs. peripheral bond yields narrows (peripheral yields fall while German yields rise), this is boosting European stock markets. Combined with further gains for the Chinese index, news of a Greek deal has helped boost global stock markets, with European indices up more than 1% so far, and US futures also pointing to a positive open.

Overall, this boost in risk sentiment could be threatened if Greece fails to complete negotiations in the coming days. So, continue to watch out for headlines from Athens…