Morgan Stanley thinks Greece is likely to stay in the eurozone, but offers a few hedging tips just in case they are forced out
While there’s still time for Greece and its eurozone creditors to reach a compromise, yesterday’s Eurogroup negotiations weren’t terribly promising and the ECB’s review of Greek ELA tomorrow probably won’t be either. Since Morgan Stanley shortlisted Greek government bonds as one of the 15 best trades for 2015, it’s revisiting those positions (in a report that came out just prior to the Eurogroup meeting) with advice on how to hedge against a Grexit.
“Having shortlisted Greek government bonds as one of our 15 top trades for 2015, we admit that it is proving a rather uncomfortable wait. We think that valuations reflect significant bearishness (one can take an 80% haircut on Greece and still be paid a higher yield than BTPs, for example) and a compromise in the best interest of all parties. But we still need to think through the risk that we are wrong,” writes Morgan Stanley cross-asset strategy analyst Andrew Sheets.
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Morgan Stanley still expects Greece to make a deal with its creditors
In the report, Morgan Stanley analysts put the odds of a Grexit at 25%, and since they weren’t counting on a breakthrough at the Eurogroup meeting that forecast probably hasn’t shifted much. They expect this to cause a mild eurozone recession, with the tail case of banking risk effecting the rest of the EU periphery and causing much bigger problems.
They think there’s a 20% chance of having a situation like Cyprus, with capital controls and a modified plan until Greece starts to actually recover, creating a drag for eurozone growth but not pulling it into a recession.
And the most likely scenario according to Morgan Stanley analysts, at 55%, is still that a compromise is reached without a debt haircut or the imposition of capital controls, and life goes on as before in the rest of the eurozone.
Two possible hedges against a Grexit
The report warns that equity hedges look expensive, and since most eurozone indexes are made up of large corporates (with minimal Greek exposure) they may not be that effective anyway. A better way to hedge is with a short EUR/USD position. A messy breakup of the eurozone, Morgan Stanley’s tail case, would likely cause a flight to quality at least until the dust settles (also benefiting US Treasuries). But even if Greece hammers out a deal, short EUR/USD was already looking attractive because of the differing monetary policies.
Another option is the iTraxx Financials Senior Index versus the iTraxx Main, which has compressed considerably since the last euro debt crisis.
“Even if we go back to 2013 only, there is considerable upside – we see as much as 50bp. In the short term, we see the cost of the hedge being limited to about 8bp of tightening. Thus, this trade has an almost option like upside/downside,” writes Morgan Stanley analyst Srikanth Sankaran.