27 January 2020
Greeks stand in line to withdraw money from a cash machine after the government declared a bank holiday. Photo: Reuters
Greeks stand in line to withdraw money from a cash machine after the government declared a bank holiday. Photo: Reuters

How Greece will deepen Europe’s season of discontent

We get asked about the stability of the eurozone and, more broadly, the European Union.

Greece is most prominent in the headlines — a precarious situation that will unfold over the first few days and weeks of the third quarter.

Despite the prolonged stalemate among the negotiating parties, our view has been that a deal would eventually be reached.

As the June 30 debt repayment deadline drew closer, however, the odds of default and “Grexit” increased markedly, especially after the Greek government’s call for a July 5 referendum on the proposed terms set forth by the country’s creditors on June 25.

If the public votes no, or Greece fails to pay back a 20-year, 20 billion yen (US$162.6 million) samurai bond maturing on July 14 — which could trigger a cross-default on other debt even before the July 20 payment to the European Central Bank comes due — the European Central Bank would become the real backstop.

The markets appear to have tremendous faith in the ability of this ECB backstop to tackle any volatility that might arise.

Nevertheless, there is a political imperative to avoid the significant fallout from such an outcome.

If Greece chooses to leave the eurozone, other countries could be emboldened to consider more publicly the pros and cons of staying in the common currency, making what was considered an irreversible step reversible.

This would also open the door for the markets to speculate about which EU members might be next to go.

What could happen in the United Kingdom is one such conjecture.

After winning reelection with a narrow majority this May, the Conservative Party has moved quickly to negotiate with EU leaders before political infighting and national elections in France and Germany destroy any chance at reform.

A referendum on remaining in the EU now looks likely to happen next May and we expect the UK electorate to vote for the status quo as long as the negotiations yield the best deal possible.

The UK may be further along economically than the rest of Europe but the risk of increased volatility politically makes us somewhat skeptical about this market over the next year.

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Chief economist and fixed income portfolio manager at MFS Investment Management