The second key risk event this year, though one with a substantially lower probability attached to it, relates to a possible negative outcome to current negotiations between Greece and its creditors. Although Greece’s request for an extension of the original bailout marks a first step toward an amicable resolution, our House View remains that it is only the first step in a long process that we expect to culminate in a compromise that keeps Greece in the Eurozone.

This process should extend for several months, and includes additional steps, including the negotiation of completion of the existing bailout, the approval by the Greek parliament, negotiations of the new program, and subsequent approval of the new program by Greek and national parliaments. With government funding and bank liquidity needs always close at hand, the chances of a misstep along this road and the sudden emergence of a crisis are nontrivial.

That said, the potential for significant contagion related to a Greek exit is much reduced relative to previous euro-crisis episodes, for several reasons. First, foreign exposure to Greece is much lower, with foreign banking sector claims on Greece 80% below the post-crisis peak. Second, the vulnerability of other European economies to shocks is much reduced. For example, foreign ownership of public debt has declined substantially in countries such as Italy and Spain. Finally, the Eurozone has erected significant firewalls to protect against the spread of future crises, including the newly initiated quantitative easing program.

Eoin Treacy's view

Here is a link to the full report. 

Greece will remain within the Eurozone for as long as it is can abide by the agreement it has made with the so called troika. Some might believe this to be a Faustian compact but if we look at the evidence, the EU is willing to extend assistance provided Greece continues to show progress on improving its standards of governance. The question of course is to what extent Greece is capable of continuing to make the sacrifices necessary to ensure the flow of funds. After all we are talking about people, not data points, and the necessary adjustments have been extreme. 

We could expend hours debating the potential for Greece to exit the Euro and still be no closer to answer. However Greek government bond yields are a barometer. It is noteworthy that despite the beginning of the ECB’s QE program, Greek sovereign yields continue to rise and the progression of higher reaction lows, evident since September, remains intact. As long as this trend remains in place, the question should perhaps be as to when rather than if Greece will leave the Euro?

The recent outperformance of the Euro Stoxx has been heavily influenced by the weakness of the currency, but the medium-term implications of the Euro’s move are more important than that. The consolidated foreign earnings of Eurozone Autonomies are being flattered. The Euro’s weakness is also lending a competitive advantage to European exporters that will translate into meaningful advantages over the medium term. 

In many respects the same strategy that was applied to Japan at the dawn of its QE program can be applied to the Eurozone today. If the comparison holds, the stock market is likely to be sensitive to the movement of the currency. The Euro has fallen by 10¢ cent against the Dollar since February and a short-term oversold condition is evident. Considering the fact that the ECB has only just embarked on QE, there is little cause to be bullish and the weakness of Greek debt is an additional headwind. A clear upward dynamic will be required to check momentum.