This is the eurozone risk investors are ignoring

Published: Feb 20, 2015 3:21 a.m. ET

Financial contagion gives way to political contagion

http://www.marketwatch.com/story/this-is-the-eurozone-risk-investors-are-ignoring-2015-02-19

NEW YORK (MarketWatch) — Greece, as you may have heard, is hurtling toward potential default and a potential exit from the eurozone. Investors are largely taking it in stride.

After all, the backdrop is significantly different than in 2011 and 2012, when Greece’s problems were spilling over to other eurozone countries, inspiring fears of a messy euro (EURUSD, -0.23%)  breakup and carnage in the region’s banking sector.

Now, much of Greece’s government debt is held by official institutions rather than eurozone banks; the European Central Bank is preparing to buy government bonds through its quantitative easing program. The ECB could also use bond-buying through the never-yet-used Outright Monetary Transactions program, put in place at the height of the crisis in the event that Italian or Spanish borrowing costs started to soar.

“The market seems quite confident that contagion will be much more contained than it was two or three years ago, when firewalls weren’t in place where they are now,” said Nick Stamenkovic, macro strategist at RIA Capital Markets in Edinburgh.

Greece is now viewed as more of a “localized problem” rather than a systemic risk, Stamenkovic said in a phone interview.

But is that all there is to it?

Not quite. While the threat of financial “contagion” is subdued, the concern now is more one of political contagion.

“It’s not just that we’ve seen a shift in political dynamics in Greece, but we’re seeing it in Spain as well,” Stamenkovic said. Polls show Spain’s antiausterity Podemos party is the country’s most popular, and elections there must be held by Dec. 20.

Podemos shares some traits with Greece’s Syriza party, whose victory in a January election and subsequent rejection of calls to extend some of the austerity policies demanded by its eurozone partners triggered the current iteration of the region’s debt showdown.

A Podemos victory in Spain could undercut the effectiveness of the security blanket offered by the OMT program. That is because only countries that are adhering to the conditions of a bailout program — the same conditions that antiausterity politicians rail against — are eligible for the program.

“If investors think anti-austerity governments may be elected in a particular country, they may be skeptical about whether OMT would be activated for said country,” said Kevin Ferriter, economist at Capital Economics.

That’s not to say Podemos is a clone of Syriza, and analysts note the party’s momentum in the opinion polls has stalled. In addition, its main political competitor, the socialist PSOE, is more viable than PASOK, its Greek “political cousin,” which all but disappeared from Greece’s political scene, said Antonio Roldan Mones, analyst at Eurasia Group.

Stamenkovic expects Greece to eventually give ground and clear the way for a deal. But if a Greek exit, which he puts at a far-from-negligible 40% risk, does appear imminent, global markets will undoubtedly see more turmoil.

Regardless of which way Greece decides, the decision could change the dynamics of the eurozone. Then it’s time to watch what happens in Spain, the bloc’s fourth-largest economy, and whether it chooses to follow the Greek path.