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Fear factor returns to haunt the euro zone

Political risk will feature again in the euro zone next year. Elections will take place in France, Portugal, Spain (maybe even in Italy) and following the European elections last may back in May, there's a genuine fear that populist parties could rise to the fore.

A manifestation of that fear sent the Greek stock market tumbling last week after Prime Minister Antonis Samaras called a snap presidential election for this Wednesday.

Heightening that fear is the euro zone's desperate need for further stimulus and the worry that it may be harder for the European Central Bank to engage in bond-buying if political instability and debt concerns are re-emerging in the periphery.

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Antonis Samaras Greece
Odd Andersen | AFP | Getty Images

Faced with negotiating an exit from the bailout and a budget for next year, that neither the country's lenders nor the public accept as viable, Samaras is effectively using the presidential elections as a confidence vote on his government.

A quirk in the electoral system means that if Greek lawmakers fail to elect a new president, the country will likely bring forward general elections to January. Recent polls show leftwing opposition party Syriza could then become the largest political party in Parliament.

If this decision was gamble on the part of Samaras to highlight the current political and economic risks, then surely the immediate selloff in Greek assets played firmly into his hands.

Syriza leader Alexis Tsipras accused the government of creating a fear frenzy, saying that "the countdown for the ruling coalition and its catastrophic policies has already started".

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Greek government minister Vassilis Kikilias told CNBC last week there was no political gamble taking place but he also acknowledged the importance of the markets. "The polls state clearly that the Greek people do not want elections. So I feel that being calm and realistic, MPs will understand what the general opinion is, and we will hear the markets too."

Tsipras argues Greece's bailout programme has largely failed to address the country's underlying problems like tax evasion and social justice, while creating others via cuts to wages and pensions. Syriza wants to see debt reduction, increased government spending and quantitative easing (QE) from the European Central Bank. More worryingly, he's also promised voters he'll walk away from the bailout on his first day in office.

Given that the current coalition government has spent four months wrangling with its lenders over bridging a 2.5 billion euro shortfall in the current bailout programme, who knows how long it may take Syriza to negotiate a debt writedown more than ten times that size?

Greece has almost 7 billion euros of debt due by late August, so the clock will be ticking for any new government. The inversion of the Greek yield curve last week tells its own story. Three-year yields were higher than 10-year yields. This panic in shorter maturity bonds is a phenomenon normally reserved for emerging market countries when investors begin to price a short-term debt default.

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The crucial question now is whether in light of the market reaction, the troika of the ECB, fellow European Union countries and the International Monetary Fund decide to be more lenient with Samaras as he negotiates an exit from the bailout programme should his government survive the vote. Moral hazard I hear you cry.

The fact is if Samaras' gets his choice of president and the coalition survives, this may only be a temporary reprieve. Even if a general election is not held in January, the polls suggest there's a high probability we see some form of Syriza government next year.

Are we looking at a future Grexit? No, I don't think we are. Polls have shown an overwhelming majority of Greek voters want to remain in the euro, even as they watched their country sink in to a depression.

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Tsipras' challenge at that point will be to prove he's more than a populist pretender as he'd been dubbed in the past and can take the country forward and work with leaders in Europe.

The bottom line here is Samaras will now be hoping the market turmoil generated by political uncertainty and the threat of a Syriza government is enough to bring parliamentary voters to heel.

Germany's Angela Merkel and the rest of the euro zone gang must surely feel the same.

As we await the result, investors should probably start to consider the degree of populist-led political uncertainty coming elsewhere in Europe in 2015.

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