Volatility in Global Markets Ahead?

Key policymakers from the European Central Bank (ECB) and Eurozone leaders will be meeting in the coming days to discuss a possible default on Greece’s upcoming loan payments, following Greece’s vote to reject austerity terms associated with a new bailout package. Last week, talks broke down between Greece and the ECB regarding terms of continued emergency measures, and as a result the ECB declined to extend financing to Greek banks following the existing bailout package’s expiration last Tuesday. Greece closed its banks and scheduled the emergency vote in response to the ECB’s announcement.

Because Greek debt is primarily held by European governments, not by private creditors, the near-term economic impact should be minimal; the French and German economies can withstand a Greek default or other debt restructuring, and the Greek economy represents a small portion of the European Union (EU). The effect on the Euro is unclear. It seems unlikely that France and Germany will reach an accord with Greece on new lending terms, and since a common currency requires coordinated fiscal policy, it is possible that the next step is negotiating a Greek exit from the Euro. We believe that the possible political impact of the vote is more significant than the economic considerations. In the longer term, a Greek exit from the Euro may affect membership in the EU, which will have broad geopolitical ramifications.

While global quantitative easing has led to subdued markets over the past several years, the drop in European stock markets as a result of the Greek crisis and the recent decline in the overleveraged Chinese market has highlighted the difficulty of correcting structural economic issues with monetary policy. In the long term, investors should prepare for more volatile equity and fixed income markets as the European situation remains fluid, and the U.S. and Japan face similar concerns.