Greek drama never ends, rocks currencies

The week draws to a close with a vote of confidence pending in the Greek parliament around 6 pm EDT/midnight Athens time. In the worst case scenario, if the vote fails, the ruling PASOK party would be forced to engage the opposition New Democrat Party in negotiations to form a coalition government. If the parties are unable to reach agreement, which is not at all certain, snap elections would ensue in three weeks’ time under Greek law, leaving the country without a government to formally accept the terms of the EU/IMF bailout package agreed to on Oct. 26. (Possibly a caretaker/national unity government could be formed that could legally endorse the bailout package).

The risk here is that political turmoil within Greece could block the EU bailout aid, leading the government to default abruptly when it runs out of cash in mid-December. A disorderly default would see the euro and Euro-area banks get crushed and a likely global financial tsunami ensue. In the best case scenario, the vote passes and the government is able to receive the bailout funds, removing the threat of an imminent Greek default and potentially triggering a relief rally in risk assets. One way or the other, though, PM Papandreou looks to be out of a job soon, but there are many other potential outcomes in this on-going drama. In particular, should the vote fail, political negotiations could drag on through the weekend, potentially unnerving sentiment if a resolution is not found by Monday’s market opening.

While Greece has drawn all the attention this past week, there are other indications that suggest markets are ripe for a potentially significant relapse in risk sentiment. Despite reports of ECB buying Italian and Spanish government debt, Italian yields are at all-time highs and Spanish yields are at their highest levels since August. This suggests to me that markets remain unconvinced that the EU’s ostensibly comprehensive solution will actually work for countries ‘too big to bail.’ 2-year government bond spreads between troubled EU nations ( Italy , Spain , Portugal and Greece ) and Germany are all at euro-era record highs, offering another vote of no confidence on the EU plan. As well, most risk markets were only able to retrace about 38.2% of the sell-off even after the idea of the Greek referendum was scrapped. So while the Greek tragedy plays out in the foreground, keep an eye on the background of Italy and Spain.

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