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ECB to ‘act as backstop’ to protect markets from Greek default contagion

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Asset managers remain calm over the risk of contagion from a Greek sovereign default and euro-zone exit, with the credibility of the European Central Bank (ECB) and its quantitative easing (QE) programme providing a backstop to increasing volatility.

Negotiations between Greece and the European Commission, International Monetary Fund (IMF) and ECB ground to a halt as the country enters a six-day bank holiday before a referendum on whether to accept its creditors’ proposals.

They have been in negotiations with Greece over reforms to the public sector, privatisations, labour markets and pensions.

While expectations grow for Greece to default on an IMF loan tomorrow, European investment markets have opened weaker, with the Euro Stoxx 50 down 3.2%.

The FTSE100, DAX and CAC40 are all down between 1.5% and 3%.

Despite sovereign bond yields in Italy and Spain rising by 25 basis points and 32bps in Portugal, asset managers have cooled expectations that a Greek default and euro-zone exit would lead to equity and bond market disruption, and contagion to other economies.

Greek debt yields are up 346bps to 13.94% from Friday – and, should the country vote no on 5 July, a euro-zone exit becomes more likely.

Around 80% of Greek government debt now resides with the IMF and the ECB, protecting private markets; Swiss firm Lombard Odier Investment Managers said the central bank would “spring into action” should any damage occur to euro-zone periphery or high-yield debt markets.

In the short term, it said riskier asset markets would remain quiet, with shifts to safe-haven assets in German bunds and US Treasuries.

“Beyond the next few days, implications for credit (periphery sovereign and corporate) are complicated, as, depending on the damage done by markets, we are likely to see the ECB spring into action,” the manager said.

Within equities, the manager said a long-term impact on European stocks was also unlikely despite an increase in volatility over the short term, again due to the ECB’s previous market intervention.

Jean-Pierre Durante of Pictet Wealth Management said the main contagion risk remained political.

“In equity markets, the firm said short-term investments already exited euro-zone stocks after a [recent] 10% correction, with longer-term investors carrying on in equities based on the impact of QE in fixed income markets,” he said. 

“We can expect that equity markets should not correct much more than 5%.”

Durante said bonds were a market to monitor, and key to it would be contagion risk to other bailed-out euro-zone economies.

AXA IM’s head of research and investment strategy, Eric Chaney, said that, while the euro-zone awaited the outcome of a Greek default, volatility would settle in, with the euro down against the dollar by about 5%.

“Other markets will decline, though to a lesser degree,” Chaney said.

“We see global markets down by around 5%, depending on the stock market beta. As the US will be considered as a safe haven, Wall Street will correct less; other markets will presumably print deeper red numbers (on uncertainty and fear).”

He warned Spanish and Italian debt yields could rise by 3 percentage points.

However, Brewin Dolphin warned the risk of contagion was being underplayed.

“We cannot take the creditors’ claims that contagion will be contained at face value – rather, these statements were made to strengthen their negotiating positions,” it said.

“The contagious implications are that any creditors to euro-denominated cross-border loans will be sweating now.

“German banks have some $13bn of cross-border exposure to Greece, with US and UK banks holding similar amounts.”

However, it added: “Some of this will be secured on euro cash flows, so the exposure looks limited overall – particularly in the context of Lehman Brothers’ nearly $800bn debts.

“The economy is stronger and the banking system than those dark days.”

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