Faced with a hard deadline, a collapsing banking system and an economy that is seizing up, Greece blinked. It submitted to its creditors a request for a new three-year loan and offered a set of reform proposals that looks a lot like the creditors’ demands that were soundly rejected by Greek voters in the recent referendum. Greece underlined its need for substantial debt relief, which is indeed essential. Even German Finance Minister Schäuble has agreed with the IMF that Greek’s debt is unsustainable. Meetings this weekend are expected to determine whether a deal can be struck. German resistance to debt relief remains the biggest question mark. Signals from other Eurozone countries have been quite positive. There seems to be little chance of an outright “haircut” or debt write-off. What is likely instead is a significant debt restructuring. While Germany will take a tough line, in the end it will not wish to be responsible for a failure to keep the euro, the symbol of Europe’s economic and political integration, together.
Path To Parity
As expected, the euro and Eurozone equities are getting a boost from the enhanced prospects for a deal. As this note is written, Eurozone unhedged ETFs are up from 4% to 5%, with one percentage point accounted for by the stronger euro. We continue to expect that in the medium and longer term the euro will resume its path toward parity with the US dollar. The European Central Bank (ECB) looks set to maintain its substantial asset purchase program for several years at least, keeping interest rates very low; and the US dollar bull market should also continue for some time yet.
EU Stocks
Eurozone equities, on the other hand, have a good chance of outperforming in the coming months. Continued low interest rates will provide a tailwind, while the expected future weakness in the euro will help exports. The Markit Eurozone Composite Purchasing Managers’ Index (combining both manufacturing and services) indicates that both economic growth and job creation reached four-year highs in the second quarter. In June, economic growth accelerated in the three largest Eurozone economies – Germany, France, and Italy. Growth in Spain slowed but Spain still held second place in the growth league. Its strong economic performance is attributed to the ECB’s stimulus and continued low inflation. The Eurozone’s economic growth this year may reach 1.8%, twice last year’s 0.9% growth, and could exceed 2% in 2016. Accelerating economies are bullish for equity markets.
Bill Witherell, Chief Global Economist