Greek Deal or No Deal: Investors Question Which Is Worse for Euro

Months of brinkmanship have tarnished the currency’s outlook, some money managers say

The Wall Street Journal

By TOMMY STUBBINGTON

June 26, 2015 7:30 a.m. ET

10 COMMENTS

Last time Greece headed for a potential departure from the eurozone, investors dumped the euro, betting that an exit would be a disaster for the currency. This time, they’re not so sure.

Even if Athens and its creditors cobble together a last-minute deal that keeps the country in the currency bloc, some money managers say that months of fraught negotiations and political brinkmanship have tarnished the euro.

“The credibility of Europe has been damaged: that should be reflected negatively in the euro over the next couple of years,” said Daniel Loughney, a portfolio manager at AllianceBernstein, which manages $500 billion of assets.

If a deal is struck, the longer-term implications for the currency depend on the nature of that deal, according to Mr. Loughney. For example, if Greece's creditors secure most of their demands, faith in the eurozone would be strengthened. But if Athens forces them to back down, upstart political parties in much larger economies like Spain and Italy could be encouraged to seek similar concessions from Europe's establishment.

“The market will be much more sensitive next time round. The stakes will be much greater,” Mr. Loughney said.

Investors’ calculus has shifted since previous episodes of the long-running Greek crisis. In 2012, as Greek voters threatened to reject the country's bailout, government borrowing costs in Italy, Spain, and Portugal ballooned as bondholders worried that a Greek departure could spark a wider breakup of the eurozone.

 This time, markets elsewhere in Southern Europe—and the currency—have been largely insulated from the crisis. Greece is no longer so enmeshed in the region's financial system, with little of its government debt still held by banks and private investors outside the country. And the European Central Bank’s bond-buying program, launched in March this year, provides a backstop for government debt markets.

Greece’s exit from the eurozone could be a “positive thing,” according to Franklin Templeton Inc. bond-fund manager Michael Hasenstab.

“The eurozone is ring-fenced with ample liquidity, so a tumultuous event in Greece isn’t likely to create much of a ripple,” he wrote in a blog on the company’s website this week.

 Some investors wonder if Greece could be more of a nuisance if its stays in the euro.

“The whole of Europe might need to sacrifice to save Greece,” said Stephen Jen, partner at investment company SLJ Macro Partners.

 The ECB would be more inclined to stick with its bond-buying stimulus for longer, effectively printing more euros and dragging down the currency, according to Mr. Jen.

“They would need to continue to inoculate the rest of the euro area,” he said.

 While the euro has remained resilient during the current crisis, the longer-term implications for the currency are more negative, said James Kwok, head of currency management at Amundi, which oversees €950 billion ($1.06 trillion) of assets.

“Long-term investors like reserve managers need to attach risk premium to the single currency and therefore how this crisis is handled by Europe is very important, despite the small size of the Greek economy,” he said.

 Despite these concerns, investors have been reluctant to place wagers on the euro around the outcome of Greek talks.

 The swings in sentiment and unpredictable political negotiations are “too unreliable to base an investment strategy on,” said David Kohl, head of currency research at Julius Baer, which manages 289 billion Swiss francs ($309 billion) in assets.

 This reluctance has helped the euro. ECB stimulus contributed to the currency’s plunge to a 12-year low of under $1.05 in March from nearly $1.40 last summer. Since then it has rebounded, but negative bets on the currency remain popular. Investors have scaled back these bets as the Greek crisis injected uncertainty into markets. The euro currently trades around $1.12, up 2% so far this month.

Investors are also very cautious about betting on a euro rise in the event of a Greek exit, even if they think a return to the drachma could leave the rest of the eurozone stronger in the long term.

 Fears of financial contagion from a Greek exit may have eased in recent years, but such an event could still provoke market shock waves that would be hard to predict, said Mr. Jen of SLJ Macro Partners.

“The idea that the euro is stronger without Greece is an interesting concept and probably correct, but it's hard to see that as a reason to buy the euro,” he said.

 And many still believe a Greek exit would be far worse for the currency than a last-minute deal.

 Markets would once again start to question whether Portugal, Spain, or Italy could follow Greece out the door, according to Paul Lambert, head of currency at Insight Investment, which manages about £400 billion ($628 billion) of assets.

“The dollar works because no one ever imagines that California is going to leave the U.S., no matter how bankrupt it becomes,” he said.

“If Greece goes from the euro, people will be wondering who's next.”

Write to Tommy Stubbington at tommy.stubbington@wsj.com