Let’s look at the Greece issue first as by the time this article is published the country will probably have been thrown yet another lifeline by the EU and other creditors in the form of €7.2 billion to shore up the country’s finances through the summer.  Investors have been showing relief with equity markets bouncing, but even if a deal is agreed, it then has to be ratified by the Greek parliament who have of course been voted in on an anti-austerity ticket, so this is just one of the high hurdles needed to be overcome.  Ultimately though a deal would be a short-term fix that only buys Greece a few more months’ time before we will see the problem resurface.  Without some sort of debt restructuring a bailout resolution will mean prolonging of what is widely being accepted as inevitable and in the eyes of many investors when Greece does finally leave the euro, such a break-up further down the line should be more manageable.  A default and resultant Grexit will cause much short-term pain, but is potentially better in the long run for Greece and its creditors as now contagion risk is less than it was three years ago.  The only problem with the latter scenario, which is the reason why there has been so much time and resource vested in negotiations, is that it means an end to a single currency project that was never supposed to fail and if it’s alright for one member to see an end to austerity whilst having their outstanding debts written off, then other members such as Spain, Portugal, Ireland and even Italy will be asking why isn’t it the same for them.  Either way the financial markets are becoming more and more accepting of whatever the outcome of these negotiations, the main reason why they are seen by so many as being inconsequential is because a Grexit remains firmly on the cards.

As if this wasn’t enough of a headache for investors there’s the other issue of having to deal with the commencement of central bank monetary tightening.  Whilst a few central banks around the globe continue to ease monetary policy, for example earlier in the year the European Central Bank introduced its long awaited quantitative easing program and more recently the Bank of Korea, Reserve Bank of Australia and Reserve Bank of New Zealand cut their interest rates, the Federal Reserve and Bank of England are getting twitchy trigger fingers to commence hiking.

Whilst we are still some way off those first rate rises with question marks over whether even the Federal Reserve moves this year or in 2016, investors, businesses and consumers have been used to ultra-low interest rates for years and are nervous about monetary tightening.  The Federal Reserve is significant because any rising of interest rates has ramifications beyond the shores of the US, in particular emerging markets as it makes their debt, much of it dollar denominated, more expensive.  We saw the potential of an emerging market rout back in 2013 when the Fed commenced the tapering of its quantitative easing and even though most emerging market currencies have depreciated considerably since then, the trend could easily continue as this time these economies not only have to deal with the prospect of more expensive debt, they have to do so at a time when many countries across the globe are seeing growth stall.  This combination has the potential to make their currencies depreciate even further against the dollar, making their debt problems worse.

Ultimately, the world is going to find interest rate hikes hard to stomach as we’ve been used to near zero rates in many major developed economies for almost seven years.  At least we can be safe to assume that when rate hikes do come, they are likely to be gradual rather than precipitous, with the tightening cycle for the Fed expected to peak around 3.00% towards the end of 2017.  But this may not be enough to put investors’ minds at rest during the remainder of 2015.

Angus Campbell
Senior Analyst