Eurozone worries are once again rattling financial markets. In this CIO Perspective, Andrew Wells, Fidelity’s Chief Investment Officer for Fixed Income takes stock of the situation, giving his views on recent developments in France and Greece.
HOW DO YOU VIEW RECENT DEVELOPMENTS IN FRANCE?
Now that recent elections in Europe have concluded, I think the real work begins. When you’re electioneering you can make lots of promises but the reality is that France now has a choice between being a part of northern Europe or southern Europe. It can become the leader of the “problem children” such as Italy, Spain and Greece or it can become the heart of Europe with Germany. For the last 60 years, France and Germany have acted together to form a strong Europe. The reality however is that although President Hollande wishes to be pro-growth he must also be responsible - he needs the eurozone to remain whole and not be broken up - he also needs the support of Germany in this process. The only way he can spend more money is to issue more bonds. And the only way he can issue more bonds is to keep the interest rate low. To achieve his goals, Hollande will have to get German Chancellor Angela Merkel to agree to some inflation, to open the purse strings and at the same time keep Germany happy and involved, so that interest rates are low and France can afford to spend.
So we are at an interesting point now in terms of what Hollande has promised the electorate and what he will be able to deliver. The lesson from history is actually that Socialist leaders in France have not been irresponsible in terms of finances – we need to make a distinction between the political rhetoric and actual financial policy. Hollande will likely ask for some compromise from Germany but not too much, in terms of relaxing austerity. Hollande is a realist. He cares passionately about the French people and the average man on the street. He does not want to destroy France. We will see higher taxes leading to some people and companies potentially leaving France. But I think, in the end, Hollande will be pragmatic.
WHAT ABOUT THE SITUATION IN GREECE?
The situation in Greece is much more dangerous. Here the two main political parties have lost all public support. Essentially, anyone who agreed with the main body of the eurozone beforehand has lost the backing of the people. Now we have all of these more extreme small factions growing in strength and they all want to re-word past deals with the eurozone. And this may well be the cause that will see Greece break away from the eurozone. All of the new parties are saying they’re willing to tear up the deals signed beforehand. Greece needs to make spending cuts of around US$3 billion in the next few weeks. Unless these are agreed, Greece won’t get the next tranche of funding, and if this doesn’t happen, then the situation becomes very dangerous. I think most people realise that this is a tragedy for the people of the country but in terms of its size, Greece is a very small part of the global economy. So this is something that should help to limit the broader damage – but only as long as this problem can be isolated from Italy and Spain.
The risk of a disorderly Greek exit from the eurozone has clearly increased. This is because there is no political cohesion and a lack of clarity – getting agreement is difficult now with so many different parties and so many different deals. Ms. Merkel must be considering her options. If a deal is done, the government could change in a matter of weeks and we’d be back to square one. However, it is important to note is that these events have largely been priced into the bond market. Indeed, the reconstructed bonds in Greece are trading way below their issue price, about 50% below. This means that the market doesn’t believe these bonds will be repaid in full. Moreover, there are very few retail and institutional investors still involved in this market.
WHAT IS THE LIKELIHOOD THAT GREECE WILL EXIT THE EUROZONE?
That’s obviously a difficult question. I’d say around 50:50, but it’s all about politics and things can develop very rapidly on this front. Politics changes things and right now it seems that public opinion is driving the agenda. If you’re a politician in Greece then clearly you must listen to the public otherwise you won’t have a job and right now much of the public is saying that it doesn’t want anything to do with the eurozone
Portugal also has issues, but we believe it will stay within the eurozone, as will Ireland, because support is stronger and because there are very few elections on the horizon. On the whole, what is needed is more time. The problems of the eurozone will take a number of years to resolve. We need economic growth, we need a re-pricing of labour in Italy and Spain, and some banks probably need more help with restructuring and bad loan portfolios. It’s very hard to see these issues sorted out in less than 3-5 years. It also depends on how fast the US, Chinese and other external economies grow. If you look at recent German industrial production data, it’s quite good, the German economy is actually doing well. A relatively weak euro is good for Germany and in return we’re seeing a transfer of assets from Germany to southern Europe. In a sense then, Germany is paying for a cheap euro by subsidising the periphery.
Looking further ahead, fiscal integration may be the ultimate goal so you can have a harmonisation of taxation, fiscal policy and budgetary responsibility. However, that also takes time, including for the electorate to realise that it’s in their interest. Despite the problems in Greece, I think the risk of the whole eurozone system collapsing remains small because the consequences of this would be so dire that strong action would ultimately be taken to prevent this.
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