Asia Unwitting Player in Greek Tragedy

Not since the Battle of Thermopylae in 480 B.C. — or at least since the movie “300” dramatized it in 2007 — has Greece proved such a pain in the Acropolis to Asian portfolios.

First you had Xerxes, chief investment officer at Persia’s sovereign wealth fund, who wanted to diversify his central Asian exposure by kicking some European assets. Xerxes outbid Leonidas and his obdurate Spartans at Thermopylae only to spark a series of proxy battles that cost the Persians Greece, and culminating in the takeover of Persia by a white knight from Macedonia, Alexander the Great.

Now, after a debt crisis in 2009 and two bailouts, the Greeks are at it again, threatening to overthrow the terms of their rescue by the Eurozone and the International Monetary Fund. The leftist coalition leading polls ahead of a snap election Jan. 25, Syriza, has vowed to demand debt relief and jettison the fiscal austerity Greece accepted as part of the deal.

Despite threats from France and Germany that Greece could be chucked out of the Eurozone if that happens, a Grexit appears unlikely. More likely is yet another Byzantine compromise, which poses its own problems to global markets: if Greece can renegotiate, might not Spain and Italy and Portugal, too? Any sign that Europe’s underbelly is going softer will strengthen hard-liners in Berlin trying to thwart the European Central Bank’s plan to buy government bonds and so release the kraken of quantitative easing to save Europe’s flagging economy.

That explains why global markets, including those in Asia, have responded with a chorus of disapproval to the prospect that Syriza leader Alexis Tsipras — not 300’s buffed star Gerard Butler — might be cast as Greece’s next champion. Global investors are already on pins and needles about an imminent interest-rate increase by the U.S. Federal Reserve, ending an era of cheap dollars that has supported risky emerging markets everywhere.

In fact the biggest thing investors worry about is not whether Greece leaves the Eurozone, but whether Fed chair Janet Yellen might raise rates sooner or more sharply than they expect. Following the end of the Fed’s quantitative easing last October, Japan has stepped in to numb some of the pain with a money-printing program of its own. But investors have been counting on the ECB to do its part, too.

So anything that casts doubt on the ECB’s quantitative easing requires a re-pricing of risk in anticipation of the Fed’s great interest rate hike of 2015. Like Thermopylae, therefore, the gore and bloodshed in markets this week is a prelude to bigger battles to come. How markets responded Tuesday, therefore, provides clues as to how investors will react later, where they’ll flee from and where they’ll seek refuge.

Forget for a moment the 3% decline in Japanese stocks – the market there has become so volatile that a move of that magnitude isn’t extraordinary. The markets that saw truly unusual blows, according to data from Reuters, were trade-dependent Hong Kong, Singapore, Australia and Taiwan. The most dramatic decline relative to recent performance was in South Korea, where the index dropped 1.74% to its lowest since August, 2013. Despite the fact that Korean exports are now more closely tied to China than the West, investors still treat it as a proxy for global trade, one that would suffer if the ECB fails to keep Europe from sliding further toward deflation.

Investors also scrambled for the safety of government bonds, with Japan seemingly the safest haven of all. Yields on Japanese government bonds fell to record lows. This may seem puzzling given that government debt is more than twice Japan’s gross domestic product, but Japan is one of the few countries that borrows largely in its own currency from its own citizens, insulating it from sharp shocks in global credit. Much of the money retreating from risky markets around Asia, moreover, belongs to Japanese investors, for whom there’s no place as safe as home. Stocks there fell because the yen was pushed up by inflows.

Where investor fears were best exposed was in the market for insurance against governments defaulting, an expression of the risks posed by receding liquidity and higher interest rates. Credit-default swaps on sovereign debt rose most sharply in Malaysia, which has one of Asia’s highest exposures to European lending, as well as in Thailand and Indonesia. At one point even China’s CDS soared.

The real surprise was the Philippines, whose low debt and current account surplus made it a safe haven during previous Euro-ructions. CDS spreads there jumped Monday almost 10 basis points to 97.5 basis points. That raises the question: With campaigning for 2016 presidential elections already heating up, investors may have detected a whiff of vulnerability in Manila’s financial fortifications.