The Greek summit and why we wont give up on the EUR

June 19, 2015

So, the Eurogroup meeting ended without an agreement for more bailout funds for Greece. There were rumours that the EU and ECB would extend its deadline for funding until the end of the year, thus allowing Athens to avoid default at the end of this month, but that rumour turned out to be just that, a rumour.

The meeting has ended with Europe’s finance ministers still unable to find a resolution, even though the Greek finance minister presented a new programme of reforms to his creditors. While the finance ministers have failed, the onus now falls on Europe’s leaders, who are planning to hold an emergency summit on Monday to try and reach a resolution. This means one thing: the big guns are out: Merkel is intervening.

This is significant since Merkel’s Germany will need to cough up the money to keep Greece afloat, if she walks away from helping out Athens then all hope is lost and default will be inevitable.

A different type of Greek crisis:

Cast your mind back to 2012, the last time that Greece teetered on the brink of bankruptcy and Eurozone expulsion, and the ECB chief Mario Draghi said that he would do “what it takes” to save the Eurozone. This calmed Greek fears and caused risky assets to rally. We have reached the moment where someone needs to stand up and say they will do all that it takes to save Greece. This would be the only outcome, in our view, that can stem the 18% decline in the Greek stock markets over the last week and cap Greek bond yields.

Do the markets care about Greece?

This time though, there is a big difference; saving Greece is not the same thing as saving the Eurozone. This is because contagion to the rest of the currency bloc has not been a feature of this crisis. We believe that this is down to three factors: 1, Ireland, Spain and Portugal are in stronger fiscal and financial positions than they were in 2012. 2, the Greek political stance has been radical during these negotiations, the political backdrop is not replicated in other Eurozone states. 3, the private sector only has limited exposure to Greece, thus recent declines in Greek asset prices does not mean that there has been enhanced downward pressure on other European peripheral markets.

The sanguine EUR

This is one explanation for the EUR’s nonchalance during the ups and downs of this Greek crisis. The single currency had been trading above 1.14 earlier on Thursday on the back of a dovish Fed meeting for June and also a rumours that Greece’s bills would be covered until year end. When those hopes were dashed, EURUSD fell back 50 pips to 1.1360, not bad considering how volatile the EUR has been during other periods of Greek stress.

Interestingly, the spot market is fairly sanguine, but there has been a lot of activity in the options market suggesting that traders are hedging their bets, putting upward pressure on EURUSD 1 month volatility. Thus, if there is no breakthrough at Monday’s summit we could see volatile trading conditions for EURUSD at the start of next week.

We continue to stick with our view that EURUSD will not fall back to this year’s lows at 1.05 in the coming months. Instead, we would expect a knee-jerk reaction lower towards 1.12 and then 1.1050 if we don’t see a breakthrough at Monday’s summit. If the sell off is sharper than we expect then we may even break this level and get back to 1.08, however, in the long-term we are neutral on the EUR. The reasons are two-fold:

Greece is considered a political not a financial problem, thus should not have a long-term effect on EUR-based asset prices.
The Fed has stated its sensitivity to dollar strength, which could limit upside in the greenback over the summer months.

Thus, we’re not giving up on the single currency, and any sell off post Monday’s summit could be a decent buying opportunity.

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