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Greece: Back from the Precipice for Now

European stocks and bonds have bounced on hearing the news of the Greek bailout deal from Brussels but this will be shortlived warns Morningstar's Andy Brunner

Andy Brunner 14 July, 2015 | 2:42PM

This article is part of the Morningstar's Guide to Emerging Market Investing. Click here to find out just what an emerging market is and which regions hold the potential to boost your investment portfolio. 

The news of the bailout deal from Brussels yesterday was initially relayed with headlines such as "European Summit Strikes Bailout Deal to Keep Greece in Euro”. Unsurprisingly, financial markets took the news well, with European equity indices bouncing some 2% in early trading and holding onto the bulk of those gains by the close. The Euro Stoxx 50, which fell heavily during the week of the referendum “No” vote, has jumped 9% from the lows and is now close to its best levels in several months.

Similarly, EU peripheral bonds reacted positively to the news, with the Spanish 10-year yield closing at 2.11% compared to a recent spike of 2.60%, and the spread over 10-year German bunds fell back to 125bp. The euro, having initially rallied against the US dollar to 1.12, eased to 1.103 by the close.

During the day more details of the weekend’s negotiations emerged and, while most commentators believe that Greece is more likely to remain in the euro area than leave it, all that has so far been agreed is a basis for negotiations on an aid package that is a fragile compromise proposal. There are major obstacles to overcome, many of which could potentially derail the negotiations before a third bailout is finalised.

The initial agreement may prove to have been the easy bit for both sides, even though the deal goes quite a lot further than the creditors' proposals rejected by Greek voters in the recent referendum. Amongst many other major issues, the Greek parliament needs to approve the reforms linked to the bailout by tomorrow in order to attain the external financing. Yet there is still a lack of clarity about the terms of the deal and there may have to be an election and a new government.

Meanwhile, negotiations over bridging loans will be extremely difficult, there are serious doubts about Greece’s ability to enact the required reforms, and there is a lengthy validation process which needs the German parliament’s approval before even starting negotiations on the next bailout.

The list of problems is endless, but the message is that Greece will only remain in the EU if it accedes to the terms and can then implement them. On that basis, uncertainty is set to persist and the hardest part still appears to lay ahead.

So far, only JP Morgan has lowered its euro growth forecasts – Q2 to 1.75% from 2% and Q3 to 1.75% from 2.5%. It should be noted, however, that JP Morgan’s estimates were well above the consensus.

As for the financial markets, the slight weakening of the euro against the US dollar appears a more apposite response and, after such a strong rally, it may prove difficult for European equities to make further near-term headway although the medium term overweight recommendation is retained. Similarly, the rally in EU peripheral bonds may well run out of steam at current spread levels.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Andy Brunner

Andy Brunner  is Head of Investment Strategy, Morningstar UK

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