The Future Of The Eurozone
It could be that the eurozone is downsized to a smaller, stronger, homogenous group of countries. It could be a collection of nations with somewhat ceded sovereignty and better political and fiscal union. Or it could be a complete breakup of the union altogether. Sadly, it is impossible to know which of these outcomes will occur, but one thing we can be certain of is that Europe will look different in ten years. In short, the status quo does not work.
Greece as a catalyst?
The biggest risk of a Greek default is that it will lead to an exit of the common currency. Because Greece is relatively small, the direct impact on the structure of the eurozone will likely be fairly minimal. Furthermore, the result may actually be favourable for Greece in the short-term. It will allow its own currency to devalue, making future debt payments easier and less costly to pay. A depreciated currency will also mean that Greece can improve its competitiveness by making Greek goods and services more attractive to overseas buyers and investors.
The problem of a Greek default however is that it would raise the probability that other countries follow suit due to contagion effects, or simply because these countries find it favourable to do so. An exit of a larger country, like Italy or Spain, will have a far more dramatic structural impact on the region. Even if a Greek exit only marginally increases the likelihood of exit of a larger economy, the impact on the markets will be significant in the form of heightened volatility arising out of the uncertainty. It will likely translate into higher bond yields for the periphery nations, which makes it harder for these countries to pay off their debts and thus provides a drag on GDP growth, which only exacerbates the situation further through a vicious cycle.
Investor Implications: Stay nimble to capitalise on opportunities and avoid risks
As the markets continue to price in the probabilities associated with the different eurozone outcomes, opportunities exist across the market, though as do risks. In ten years' time, it may well be that the countries displaying the most stress now end up providing the best value for investors. For this reason, we think it is more important than ever to closely analyse the political developments and policy responses, and remain active and nimble to ensure opportunities are taken when they arise and avoid risks as much as possible.
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