Summary of the situation in Greece | Caton's Corner
Summary of the situation in Greece | Caton's Corner July 1, 2015
Following are the views of BT Chief Economist, Chris Caton, in his monthly piece, Caton's Corner. Obviously this month, Chris has focussed his summary on the Greek situation, but still provides a broader perspective regarding other world events that are impacting markets, namely in China and the US. In relation to Australia, Chris discusses the property "bubble", the impact of the Greece situation, GDP and unemployment results.Caton's CornerTo say that June was a poor month for share markets is a massive understatement. And the reason is clear: the ongoing Greek situation. For the month, the ASX 200 fell by 5.5%, its worst month since May 2012. This was the fourth successive negative month. The index fell by 7.3% in the June quarter, the poorest quarter since the September quarter of 2011. For the calendar year to date, the market has risen by just 0.9%, while for the financial year it turned in a price gain of just 1.2%, the weakest performance for three years. The US share market, as measured by the S&P500 index, fell by 2.1% in the month, to be up by 0.2% since the start of the year and by 5.3% for the financial year just ended. On 28th June, the US share market ended a nine-week streak of daily movements less than one percent.
As mentioned, it was all about the unfolding Greek situation. Developments here are such that what I write now may be swiftly overtaken by events.
Greece spent much of the month in negotiation with its various creditors concerning payments that must be made and reforms that need to be undertaken in order to ensure continuing financial support. The first effective deadline was a payment of €1.5 billion to the IMF by 30 June. Making this payment would have “unlocked” a further €7.2 billion of funding from the IMF and ECB. More to the point, Greece is required to repay a massive €19 billion to its various creditors by the end of this year, with the next major deadline being a repayment of €3.5 billion to the ECB by 20 July. It’s impossible to see how this can be done, without borrowing much more from the very agencies to whom the repayments are due.
The Greek Debt Repayment Schedule: 40 Years of Hard Road (billion euros) The official creditors, primarily the IMF and the ECB, have been attempting to impose further austerity measures on Greece, designed to stabilise and then reduce its debt/GDP ratio over time. The Greeks, who have already undergone several years of austerity with little to show for it apart from unemployment over 25% and an economy significantly smaller than it was prior to the GFC, are naturally recalcitrant.
The Greek prime minister, Alexis Tsipras, pulled a surprise move on the weekend, declaring that he would submit the creditors’ proposals to a referendum of the Greek people, to be held this coming Sunday (5 July). The creditors promptly revised their proposal, which means in effect that the referendum will be to decide whether or not to accept an offer that is no longer being proffered. Confused? Further assistance by the ECB to the Greek banking system has been frozen. As a result it has been necessary to close the banks until after the referendum in order to stop a massive run by depositors concerned that their euro deposits may be converted into less valuable drachmas in the near future.
Having called the referendum, the Greek government is campaigning strongly against a “yes” vote. As the prime minister eloquently put it, “I call on the Greek people to rule on the blackmailing ultimatum asking us to accept a strict and humiliating austerity without end and without prospect”. The Greek people thus effectively have to choose between two things neither of which they want: more austerity or the return of the drachma. At the moment, they appear to be leaning towards the former. PM Tsipras has indicated that, if the populace vote to accept further austerity, he will oversee the passage of the necessary legislation through Parliament and then resign. The Greek people got some helpful advice from the head of the European Commission, Jean-Claude Juncker, who suggested they “say yes, regardless of what the question is”.
If the referendum is rejected, Greece will then almost certainly default on its debt. It would still be possible for it to remain in the euro zone, although unlikely. Default would not be a catastrophic market event since most Greek debt (more than 80%) is held in the official sector (although there may be a hedge fund or two with significant exposure; we won’t know until the tide goes out). The other risk is, of course, contagion. If Greece exits and (eventually) does well, this may encourage anti-austerity parties in Spain, Portugal and Ireland, for example. Further defections from the common currency would lead to its complete collapse.
One thing is clear: we are somewhere that we have never been before, and market volatility is likely to continue until the situation is resolved. Given the scale of future repayments required, it’s difficult to see any “final” resolution other than Greece eventually leaving the common currency. This will cause massive dislocation to the Greek economy, but may, oddly, be the quickest way to an eventually more prosperous future. The fundamental question, in my view, is: what is the best path to take to ensure that that the horrendous level of unemployment in Greece is eventually reduced to a more acceptable level?
So what’s the bottom line? As stated, Greece will be an ongoing source of volatility but, given its economic size and the very limited exposure of the private sector to its debt, it’s very difficult to see the situation becoming calamitous. In fact, many would see this as a buying opportunity.
In any other month, the machinations of China’s economy and markets would have attracted far more attention. The Chinese share market plummeted in the second half of the month, falling by more than 22% (although it is still up by 25% since the start of the year). The falling market was probably a factor in a further aggressive easing of monetary policy on the last weekend of the month; two key interest rates were cut by 25 basis points and reserve requirements for banks and financing companies were also reduced. Clearly the Chinese authorities remain determined to maintain growth.
Elsewhere In the United States, the data have taken a turn for the better. The Federal Reserve has indicated that it still intends to raise interest rates, beginning possible as early as September. Even when the statement was made, market analysts were sceptical, believing that a later start (December) was more likely. The developments in Europe have almost certainly pushed back the date of the first tightening; it is unlikely that the Fed will begin the process until there is more clarity in the rest of the world.
And in Oz The two most important pieces of economic information were a GDP report that was stronger at first glance (0.9% growth in the March quarter) than on close inspection (the 2.3% growth in the past year has been disproportionately due to a surge in resource exports that is unlikely to be sustained).
Potentially more important was a further strong labour-market report. This showed the third decline in the unemployment rate in the past four months, to its lowest level (6%) for a year, along with a healthy 42,000 gain in employment.
House prices remain as a key domestic concern. In the month, the Treasury Secretary, John Fraser, opined that parts of the Melbourne and Sydney markets were in a “bubble”, while RBA Governor Glenn Stevens said that some of the things going on in the Sydney market were “crazy”. I have expressed the view before that this is overwhelmingly a (domestic) investor-driven event, and that it is happening solely in the two largest capital cities. That said, whatever is happening is primarily a product of years of ultra-low rates, and certainly acts to reduce the probability of a further rate cut. The RBA is likely to be on hold for several months.
Incidentally, we have little to fear from direct effects of the Greek situation. Greece is our 68th most important bilateral trade partner. Of course, there can be indirect trade effects. And any delay in the first US rate cut will, unhelpfully, keep our currency stronger for longer.
The $A began June at 76.6 US cents and finished at 76.9 cents. Movements during the month were remarkably small, with the currency range-bound between 76 and 78 cents. My end-of-year forecast remains at 72 cents.
My end-of-year forecast of 5800 for the ASX200 (currently 5459) remains unchanged, although, as always, under review.
Chris Caton Chief Economist
The views expressed in this article are the author’s alone. They should not be otherwise attributed.