Greece and the Trioka Have a Staring Contest

Well that didn’t last long.

Greece’s political parties were unable to form a coalition government and as such, Greek voters will head back to the polling stations on June 17^th. In the interim, the anti-austerity Syriza party has gained the most momentum and that development has put markets everywhere on edge. Consider that in the past two weeks depositors have withdrawn more than $5 billion euros from Greek banks and there are also rumours of bank runs in other peripheral countries like Spain and Portugal.

Syriza party leader Alexis Tsipras is promising that he will renegotiate the terms of Greece’s bailout package and is reassuring Greek voters that the euro zone simply cannot afford to let Greece default (it is true that approx. 70% of Greece’s debt is held by foreign investors and that the largest portions of this debt are held by Spanish and Italian banks). He also knows that Greek citizens are frustrated by their austerity dominated economic prospects and he is scoring easy political points by tapping in to their visceral resentment of the foreign-led belt tightening that is sapping all hope for the future.

But Mr. Tsipras must also account for the fact that the majority of Greeks still want to remain in the euro zone. His have-your-cake-and-eat-it-too answer is to hand German Chancellor Angela Merkel a gun and dare her to pull the trigger (the gun being Greece’s next bailout payment).

Will she?

Chancellor Merkel must make a very difficult call. While a Greek default would destabilize the euro zone and risk pushing other peripheral countries into default, if she makes new concessions she will be held accountable by German voters who show little appetite for more compromise. Furthermore, any new deal offered to Greece will become the basis for negotiations with a long list of the euro zone’s other struggling countries such as Portugal, Ireland, Spain, Belgium, and Italy. That adds an order of magnitude to the true cost of any new Greek compromises.

The Greek election on June 17^th will be a day of reckoning for the fate of the euro-zone’s monetary union as we know it. Meanwhile, as the Syriza party’s popularity increases, a Greek default and exit from the euro zone (now popularly known as the “Grexit”) looks increasingly likely. Uncharted territory beckons.

Five-year Government of Canada (GoC) bond yields were 7 basis points lower for the week, closing at 1.42% on Friday as the rising demand for the safety of our bonds continued to correlate with increased fears of a euro-zone break-up. Given that five-year fixed-rate mortgages are still being offered in the 3.29% range, there is plenty of room for more discounting, but most lenders have so far chosen to let their profit margins widen instead. The only exception to that rule so far is one small lender which is now offering high-ratio borrowers a no-frills five-year fixed rate at 2.99% on a time-limited basis.

Variable-rate mortgage holders took note when Bank of Canada Governor Mark Carney recently warned that short-term interest rates might rise faster than the market expects, but he hedged his comments by acknowledging that his decision would be weighed carefully against heightened market risks, chief among them the unfolding euro-zone crisis. A messy Grexit is exactly the type of event that will cause him to recalibrate his timetable.

The bottom line: Fear should continue to dominate markets everywhere until the game of high-stakes brinkmanship between Greece and the Troika (comprised of the International Monetary Fund, the European Commission and the European Central Bank – with Germany at the controls) plays itself out. That fear will continue to fuel demand for the safety of GoC bonds and should thus keep Canadian mortgage rates at ultra-low levels until the situation in the euro zone becomes much clearer and more stable.