Greek referendum: Definitive vote ushers in further uncertainty

Greek voters sent a definitive message Sunday. They said “no” to further austerity measures required for additional bailout aid from the European Union (EU). In a 60/40 vote, Greek voters rejected EU reforms and entitlement cuts required for a new EU funding program. But according to exit polls, the referendum did not appear to be a vote to leave the euro.

At Invesco Fixed Income, our sense is that the vast majority of Greeks wish to stay in the euro, and we believe the Syriza government recognizes this mandate. That said, and despite the celebratory tone inside Greece, Greece now appears to be worse off than it was before the referendum; in many ways it is closer to bankruptcy and possible exit from the euro, in our view. We believe odds appear 50/50 at this point of a “Grexit” (Greek exit from the eurozone).

Controversial Finance Minister Yanis Varoufakis resigned immediately after the poll — a marginal sign that Greece wants a funding deal, in our view. An important date to watch will be July 20, when a EUR3.5 billion (USD3.9 billion) bond repayment is due to the European Central Bank (ECB).¹ Another large repayment to the ECB is due on Aug. 20. Without a bailout deal, Athens faces default on these bonds.¹

The risk of debt default is one of the three main issues now at stake for Greece. The likelihood of each remains uncertain at this point:

1. Debt default
2. Bank failure
3. Exit from the eurozone

We could envision a scenario in which the ECB would provide some leniency on the upcoming July debt payment, if there appeared to be a credible deal in the works. Avoiding default has important implications for the Greek banking system — a default to the ECB could interrupt the flow of ECB liquidity provided to the Greek banking system, potentially causing it to collapse. The Greek banks have been closed for the past week and capital controls imposed. It is unclear how pensions and government employees will be paid. These humanitarian concerns mean that time is in short supply to resolve Greece’s current impasse with its creditors. Next steps could make a speedy resolution difficult, however. Greece must now apply for a new program from the eurozone’s main bailout fund, the European Stability Mechanism (ESM). A lengthy negotiation process could ensue.

Implications for bond investors

The possibility of contagion will likely be at the forefront of investors’ minds in the coming days. It will be important to monitor the reaction of Greece’s official and government creditors in the aftermath of the referendum vote. However, so far, bond market reaction has been more muted than may have been expected. We believe this may be due to a couple of key factors:

• First, very little of the outstanding Greek debt is held by the private sector, and a very small amount is held by European financial institutions.  One of the primary channels of transmission of financial risk is through the financial system, and that does not look to be an issue at this time.
• The ECB has a large balance sheet that should allow it to absorb any losses generated by a Greek default.  It is unlikely to have to ask the underlying sovereigns for new capital, in our view.

While financial contagion from a possible Grexit seems limited, in our view, political contagion may be the most problematic. A Grexit could embolden other countries facing similar financial struggles to consider a similar strategy – if not immediately, then perhaps amid a future economic downturn. Thus a Grexit could set a dangerous precedent, from the point of view of creditor governments. We are still optimistic that Greece will stay in the euro, since the alternatives appear so dire – for both sides of the table. This raises the possibility of significant volatility in global financial markets in the near term as events unfold. We remain cautious, but to the extent that risks are adequately priced, we also foresee the possibility of opportunities for bond investors through active management and careful security selection.

1 Source: Wall Street Journal, July 6, 2015.

Read more about Greece:

What does the outcome of the Greek referendum mean? by John Greenwood

Robert B. Waldner, Jr., CFA

Chief Strategist and Head of Multi-Sector

Rob Waldner is chief strategist and head of the Multi-Sector team for Invesco Fixed Income. Mr. Waldner is responsible for facilitating the overall macro investment strategy for the fixed income platform and for oversight of the multi-sector portfolio construction process. He joined Invesco in 2013.

Prior to joining Invesco, Mr. Waldner was with Franklin Templeton for 17 years. At Franklin Templeton, he was a senior strategist and senior portfolio manager responsible for Absolute Return, Global Aggregate and US Core Plus portfolios. Previously, Mr. Waldner was a member of the Macro team at Omega Advisors and a portfolio manager with Glaxo (Bermuda) Ltd. He entered the industry in 1986.

Mr. Waldner earned a BSE degree in civil engineering from Princeton University in 1986. He is also a CFA charterholder.

Mark Nash, CFA

Senior Portfolio Manager

Mark Nash is a senior portfolio manager for Invesco Bond Fund.

Mr. Nash entered the industry when he joined Invesco in 2001. He was promoted to senior portfolio manager in 2007. Alongside his portfolio responsibilities, Mr. Nash became head of the Global Multi Sector portfolio management team in 2012.

Mr. Nash earned a BS degree with honors in chemistry from the University of Nottingham and is a CFA charterholder.