Greek caterpillars turns into butterfly overnight?

In a surprising turn of events the Greek government seems to have last night done a complete volte face on their negotiating position with the creditors. Indeed, the proposals look close to the Creditors’ ones from last week. And that’s the deal which the Greek electorate soundly rejected in Sunday’s referendum.  That now seems like one of the most pointless-ever votes and may indeed have done damage by further poisoning relations with the creditors. So there remain significant hurdles to overcome in achieving a deal, although Wednesday’s Reuters poll showing a majority of City economists expecting GREXIT looks more premature than it did 24 hours ago.

The remaining points of difference seem to relate to the tax treatment of the smaller Greek Islands, the slightly later implementation of pension reform legislation and potentially how quickly the (agreed) 2018 3.5% primary surplus target is reached. But the Greeks seem to have jumped over their previous red lines of VAT system and pension reform (including phasing out of the solidarity pyments).

More surprisingly, the Greek documents reportedly make no explicit reference to debt relief, which seemed to have been the main point of the referendum in the first place. They may well have taken the hint from Merkel’s comments that a formal haircut was not on the table (German politics) or decided that adopting the Irish approach of doing your negotiations behind closed doors rather than atacking the creditors via twitter is more likely to win friends and influence people. That said, the latest news is that the Greeks are looking for a bond swap deal from creditors, to help pay off the €6.5bn of maturing ECB bonds in July/August. And a Greek “non-paper” discusses debt reprofiling (extend and pretend) after 2022.

EUR has spiked sharply up on this “risk on” news, with equities and other risky assets also up. EURJPY has risen particularly sharply, reflecting the risk-appetite double-whammy of Chinese equities also rebounding, as some City firms discussed that their precipitous fall had made them buys. My post of Sunday discussed the possibility of a knee-jerk bounce on apparently-positive news, although my bias remains for EUR to fall over longer horizons irrespective of the outcome of the negotiations (see my previous posts).  Today’s relatively large bounce continues the recent tendency for the market to take a bit of a “glass half full” view of proceedings, based upon either perceiving that a last-minutedeal will be done or thinking that ECB backstops will limit contagion if one isn’t.  But its also noteworthy that EUR is still down over a longer window e.g. since the referendum was called.  And to me the risks of failure of negotiations, and potential consequences for the EA, seem greater than apparently priced by the market.  In other word we are far from out of the woods, notwithstanding the bounce in risky asset prices.

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The Greek volte face is a positive for potentially getting a deal done and probably the long-term health of the Greek economy, given the alternative of financial breakdown and fiscal constraint even with GREXIT. But you cannot help but wonder about the extra cost inflicted on the Greek economy by Syriza’s bargaining approach (until Varoufakis’s was finally sidelined on Monday). Certainly, the Greek banking system seems likely to require a significant capital injection and Greek business confidence seems likely to have taken a heavy hit.   The bottom line is that the Greek situation is far more serious than a few months ago, hence requiring larger creditor support.

The Greek people’s faith in their politicians is also unlikely to have been bolstered once the dust settles.  Despite that, opposition party backing means that the Greek plans should get approved by the Greek parliament, even if it divides Syriza.

But convincing the creditors could yet prove difficult, despite the latest Greek proposals approaching the creditors’ previous ones.  Put simply, creditors’ (Eurogroup) high mistrust of the Greeks’ ability to meet their promises, exacerbated by their erratic negotiating tactics, will have to be overcome. This underpins Schauble’s comments to “just do it” and implement reforms immediately in advance of the bailout, to “win an incredible amount of trust”. Opposition could be particularly strong amongst the smaller/poorer countries: Slovak finance minister Kazimir’s comment “one can wonder how quickly can a caterpillar turn into butterfly” betrays skepticism.  Indeed it appears that a coalition of smaller countries could in principle block a deal by preventing the lower bar of 85% of Eurgroup members support apparently allowed for in expectional circumstances being achieved.  That said, German views seem likely to be most influential/important, with France having consistently been more supportive of a deal.

Indeed the bar on creditors’ conditions could well have been raised, given that the deal now looks to be for a third bailout, probably of around €70bn, rather than the initial starting point of releasing the final €7.2bn tranche of the second bailout. Slovak finance minister Kazimir has already discussed potential further frontloading of austerity measures. So the Greeks may well need to step even further over previous red lines to secure a deal (once again bringing uncertain intra-Syriza dynamics into play).  As such, FX traders should keenly watch the weekend newswires.

Creditor politicians (e.g. Merkel) will likely be reluctant to potentially have “started the breakup of the Euro” as their epitath, even if they have a domestic audience to placate, with a deal apparently moving within reach once more. This indicates compromise from both sides, although the creditors certainly hold most of the bargaining chips given the (short-term) firewalls provided by ECB QE and OMT.

But the ECB will certainly be hoping that a deal can be done, and start being ratified by parliaments early next week, to extricate it from the extemely difficult position re continuing ELA.  Certainly the ECB GC would certainly not want to precipiate GREXIT by withdrawing ELA until it became clear to everyone that a polictical solition cannot be found (the July 20 ECB repayment represents the final deadline). Undoubtedly the ECB would be like its meeting next week to start refocussing discussion on important eurozone issues such as whether the nascent recovery has legs and whether the projected rise in inflation is robust to the recent falls in oil and other commodity prices.  But that is far from assured.

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