Greek voters take the EUR into the unknown but probably down

Exit polls suggest that the “no” campaign has scored a decisive victory in the Greek referendum, with it looking like over 60% of voters supporting Tsipras’ stance to reject the creditors’ terms. This is even though that offer has expired and Tsipras on Wednesday reportedly acceded to the majority of the creditors’ demands.

The emergency EU summit now been convened for Tuesday will have to try to overcome the apparently immovable positions of both Greek and the Creditors saying that they are looking after the democratic rights of their electorates. And the creditors are constrained in their ability to grant extra concessions by wanting to avoid the debt-forgiveness fire spreading to other peripheral countries (e.g. forthcoming Spanish elections) even if they are doing much better than Greece. Greek negotiation tactics – not telling their creditors about the referendum plan and that the Government was going to support the “no” vote, accusing the creditors as blackmailing the Greek people and representing an act of terrorism most recently – mean that relationships are strained to say the least.  So a key issue could be whether German attitudes to the Greeks have hardened: any new deal will have to be approved by the Bundestag. Overall things do not look hopeful given stated positions – GREXIT now looks like a plausible end-point rather than a tail scenario – although all hope is not yet lost.

Tsipras’ has been restating his position that the electorate have not rejected Eurozone membership, despite Merkel’s pre-referendum comments to that effect. And he continues insisting that it will buoy Greek bargaining powers in the negotiations, to the apparent disbelief of creditor representatives who view their reform requests as reasonable and probably in the long-term interests of Greece. Much will depend on whether he was serious in apparently conceding to many of the creditors’ demands last week or whether the apparently decisive no victory emboldens him.  Varoufakis’ comments suggest that the Greeks will attempt a divide and conquer approach with the creditors– e.g. playing up on the IMF’s recent comments that debt relief was important (although that was about the extra funds that were necessary to offset the damage done to the economy by the effects of Syriza policies).  But it should be remembered that the Eurogroup process requires unaminity rather than a majority.

Syriza’s claim that this is victory for all the people of Europe presumably does not take into account the potentially-damaging effects of heightened uncertainty on the still-fragile EA economy nor those pensioners made poorer by the likely hit to their pension funds as EA asset prices look set to fall.  Spanish politicians are probably most-worried about knock-on effects, given parliamentary elections forthcoming in the Autumn may reinforce Podemos’ recent gains in city elections, although recent scandals affecting Renzi’s Italian government highlight fragilities there as well.

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But the acute near-term problem is that Greek banks appear on brink of collapse – rumours swirl that some only have a few days of liquidity left – threatening the Greek economy with financial ruin (on top of the severe uncertainty effects).  Hence the German government source commented that Syriza have driven the Greek economy into the wall. Varoufakis’ pre-referendum claim that the banks would re-open on Tuesday seems like pie in the sky.

The stance of ECB on ELA will be key here. Certainly the ECB will not want, as an unelected body, to be the one to pulls the plug on Greece.  And Syriza may have internalised that in their negotiation strategy, however large the cost should that calculation prove false.  So the ECB may fudge that Tuesday’s emergency summit means that it can legitimately continue its ELA stance i.e. while there is still a theoretical possibility of a positive outcome.  But the issue is that it may require a further ELA extension to prevent at least one Greek bank falling over, which seems hard to deliver.  And clearly maintaining ELA is becoming an increasingly-stretched position, and it cannot be ruled out that Draghi et al will eventually reach the point when they say “the rules are the rules”. Certainly, a Greek failure to meet the €3.5bn repayment to the ECB would push the ECB over the edge and so represents a hard deadline (an unusual thing in the EA).

The ECB will be particularly-keen to avoid contagion to other periphery countries, which will engender a bias towards further loosening. ECB QE, however, is not ideally-suited to dealing with this kind of nascent stress.  So the OMT programme may also have to be dusted off.

And, as I discussed in my 21 June post, that is one of the factors pointing to EUR downsides in the coming days if a new deal is not done. EURUSD has been little changed since I advised on 24 June that the rapid falls in the previous three days meant that the risk-reward for shorts had deteriorated. But, as I discussed in my post of 21 June, today’s unexpectedly adverse turn of events means that EUR’s relative resilience in the face of growing Greek uncertainties may be approaching a tipping point. That resilience has reflected ECB QE and negative interest rates turning EUR into a funding currency which has been supported in a deteriorating risk environment as EUR shorts unwound, potentially amplified by FX hedging effects. But that seems to be waning: EURUSD’s negative beta on European equity prices has been notably retracing in recent days, at the same time that JPY’s negative beta has reasserted itself.  So absent a deal in the coming days that process will likely gather pace, putting downward pressure on EUR (adding to the impact of any ECB responses).  But at the least we can expect further rises in EUR implied volatilities and greater EUR downsides to be priced into risk-reversals – both surprisingly came off last week.

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Of course, Greece’s small weight in EA GDP and belief in insulating efficacy of the ECB’s toolkit mean that FX traders could shrug their shoulders about all this, at least while they wait for the mood music from Berlin and Brussels to become clearer.

Moreover, EURUSD trades face the challenge of the growing consensus that the Fed will not be a hurry to raise rates, with a September liftoff looking all but ruled out after last Thursday’s disappointing wages data.  There is definitely a lot going on in this bilateral, discouraging some trading.  So the likely elevated risk aversion environment may well see most support for traditional safe-haven currencies and the action may be more pronounced in vols and skews than in spot (my 21 June post noted that this had been the case for EURUSD).

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As such EURJPY downside look attractive, especially in light of the apparent change in attitude of the BoJ on JPY weakness (the seeming bottom line from Kuroda’s convoluted REER comments). As noted above, JPY’s negative beta on equities has reaaserted itself in recent days: there seems further room for this to run and EURJPY’s level is less unusually low that other EUR bilaterals.  EURJPY vols are also not elevated.  So strategies targetting liited EURJPY falls (e.g. put spreads) may be worth investigating.

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The SNB also took the unusual step last week of being forthright about their active recent intervention to forestall further EURCHF falls (tomorrows’s sight deposits data will be interesting). Their commitment to further interventions should the Greek situation deteriorate could be challenged by the market, given recent balance sheet size concerns. But their dilemma could be put into focus should tomorrow’s CPI release surprise negatively, so further emergency rate cuts cannot be ruled out.  Certainly Jordan’s recent comment that “everything speaks for a depreciation because we have a markedly overvalued Franc and weakening activity” appears like wishful thinking near-term.

The risks are also skewed to EURGBP falls.  While the 8 July Budget represents a risk event, markets should be well-prepared given Osborne’s drip-feed of information (including today’s comments on welfare and housing support caps).  Osborne also seems likely to cite the Greek example as underpinning the need for front-loaded auterity: the UK situation is patently very different but front-loading the deficit reduction will get it out of the way in time for the next election. And, as I discussed in my 2 July post, foreign inflows into gilts have been strong in recent months and MPC may end up being pragmatic about GBP strength given receding UK inflation downsides.  EUR downside would also offset potential damage to the EA recovery from heightened uncertainty, which would could be the best outcome for the UK given the difficult start point.  Osborne and Carney are scheduled to meet tomorrow to discuss the Greek situation.

Finally, the likely uptick in risk aversion generated by the Greek situation will likely be a challenging environment for exposed EM currencies with large external imbalances and USD-denominated debt.

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