It seems that markets have been too relaxed about the prospects for a Greek deal, says J P Morgan Asset Management in its Weekly Strategy Report (16 February).
This is despite the fact that the credit default swaps market has been pricing in an excess of an 80% probability of a Greek government default within five years.
As more talks on the Greek debt problem take place in Brussels, the asset manager cited parallels with the Lehman bankruptcy in 2009 and cautioned: "It would be wrong to assume that rationality will always prevail."
The Greek government has to deal with inconsistent objectives as a result of the general election. Opinions polls show that 75% to 80% of Greeks wish to remain in the European Union, but the size of the vote for the Syriza party in the election also indicated a clear preference for debt relief.
The end of the month sees the deadline for Greece to accept the terms of the so-called troika (EU, European Central Bank and IMF) when some investors believe that Greece could run out of money and be forced to default.
On the question of whether there are any advantages in Greece defaulting and leaving the euro, J P Morgan looked for lessons from the experiences of Argentina and Brazil.
The lesson from Argentina was that "the process of default, devaluation and recession proved to be counter-productive, because there were huge foreign exchange mismatches in the private sector and the banking system,"
By contrast, explained J P Morgan, "Brazil did not have those foreign exchange mismatches, with the result that its exit from a fixed-currency proved to be positive for economic growth."
Greece has moved into primary fiscal surplus (the budget balance excluding debt service), while the current account of the balance of payments has also moved into surplus.
"Although the primary surplus will have slipped back, as Greek tax collection has slipped amid the recent political uncertainty, it does give the country some potential leverage over its creditors," J P Morgan commented.
"Moreover, the majority of Greek debt is public debt, which is mainly owed to official creditors, but it is unclear if there are any sizeable FX mismatches. While a default would be the worst-case outcome—and a relatively unlikely one—investors should not assume that it is impossible.
"Our central case assumes that there will be some agreement, with debt relief being offered in turn for domestic reform."
So was where could active investors could find asset allocation opportunities over the next few quarters? J P Morgan noted that the Riksbank last week became the first central bank in the current cycle to move its official repo rate into negative, while announcing quantitative easing (QE). The Danes have cut interest rates four times in the past three weeks, while the Swiss National Bank has let the currency appreciate.
"These episodes reflect the difficulty of having to manage monetary policy (and central banks' balance sheets) vs. that of a much larger anchor currency."
The asset manager therefore sees opportunities in currency markets, "where valuations may be reaching extremes."
Full commentary at: http://insights.jpmorgan.co.uk/adviser/commentary-and-analysis/the-weekly-strategy-report-16-february-2015/