Grexit has been avoided,

Euro zone leaders have reached an agreement with Greece at an emergency European summit. A last-minute deal between Greece and its creditors has eased short-term tensions. Execution risk remains nonetheless high and a possible Grexit in the long run is still not excluded.

What has changed since last week?

• On Sunday 5th July, Greece voted ‘no’ during a referendum on the austerity measures and reforms required to receive another bailout.
• On 11th July, the Greek parliament gave the government of Prime Minister Tsipras authorisation to negotiate a bailout with its creditors, even with the prospect of more stringent conditions than those rejected during the referendum.
• This morning, Euro zone leaders and Greece reached an agreement to avoid a Greek default that consists of :
  • An agreement on a 3 year bailout involving 80 billion euro.
  • 35 billion euros of financial support from the Juncker plan.
  • Liquidity support for Greek banks, as the recapitalisation of the Greek banking sector will be a key issue in the coming weeks.
  IN EXCHANGE FOR
  • A “guarantee fund” based in Greece, that would hold some 50 billion euros in state-owned assets slated to be privatized or wound down in the coming years.
  • 25 billion will be used to recapitalise the Greek banking sector.
  • The remaining 25 billion will be used to make debt repayments (50%) and investments in Greece (50%) by the Greek government.
  • A list of structural reforms.

What are the implications?

Short term

A Greek default and an exit of Greece from the Euro zone has been avoided. Greece and the Euro zone leaders have agreed both on financial support and on significant reforms.

What are the next steps?

• In the coming days (until Wednesday), the Greek parliament will now have to approve the full agreement and start legislating to implement the first actions outlined in it.
• A Eurogroup call will be held on Wednesday. After that meeting, the European parliaments can start their procedures (from Wednesday to Friday). The Eurogroup and the board of governors of the ESM (European Stability Mechanism) will then take a formal decision so that the ESM can start formal negotiations (to deal with Greece’s financing needs and debt sustainability). It will take some weeks to complete the deal as there is still a lot of work (Source: European Council press conference).
• As we can understand from European declarations, the execution risks remain elevated even in the short term, as there are still many hurdles to overcome. Today’s agreement is good news today, but the story is not over yet.

Medium term

This morning’s agreement is a step in the right direction. However, even if the agreed plan is passed by the Greek parliament, a possible Grexit will remain Greece’s Sword of Damocles in the coming years for various reasons:

• Uncertainty remains regarding the implementation of the required austerity measures and reforms. It is unlikely that Greece’s creditors will provide the total bailout all at once. In this case, there clearly remains an execution risk in the coming months, and even years...
• The Greek economy has been severely hurt by the current crisis, making the question of debt sustainability all the more crucial for the future of Greece in the Eurozone. Greece’s debt-to-GDP ratio remains unsustainable in the long term. Later we will have a clearer view on the European proposals on that point (in the ESM negotiations).

What is our asset allocation in this context?

Investors welcomed the Greek agreement this morning, which is clearly a step in the right direction. In this context, we have decided to maintain our current stance on equities versus bonds, meaning a slight overweight in equities, in combination with a protective derivatives strategy.

• From a regional point of view we are maintaining our tactical hedge on Euro zone equities, that not only allows us to benefit from the market rebound, but also protects us in case of a U-turn in negotiations.
• We are maintaining our exposure to the USD, which we consider a good hedge against the Greek tail risk.

Conclusion

In our scenario, the short-term risk of a Greek exit from the Euro zone has declined, but completion of the deal (by the ESM) is still weeks ahead with no clear indication on the renegotiation of debt. The Grexit risk will therefore remain on the table in the coming months and years, as the execution risk of the bailout programme remains relatively high and Greece continues to carry a huge debt burden.