How would Grexit work?
At the time of writing, the Eurogroup of finance ministers were still locked in discussions on whether to grant Greece another bailout extension. We are expecting to hear the outcome of the decision at some point on Friday evening. If the Eurogroup wants to avoid excess market volatility then it may choose to announce the outcome of this meeting once the U.S. market has closed on Friday.
What we know so far:
Earlier on Friday the Maltese finance minister said that the “German-led” bloc in the Eurozone is willing to let Greece leave the Eurozone.
Also on Friday a German paper said that the European Central Bank is running contingency scenarios for a Greek exit.
Greece has a movable public holiday scheduled for this Monday, Feb. 23, which could give the Greek central bank time to print drachma…
The leaders of Europe are also getting involved. French President Hollande said that Greece has to stay in the Eurozone, while the German Chancellor would only say that Greece remaining in the Eurozone was her aim, but she had to see the details of Greece’s bailout extension proposal.
The Greek Prime Minister said that he was “certain” that the Eurozone will back his bond extension plan; however, it could be a tough few hours for him while he awaits the outcome of the negotiations.
We expect a binary outcome from this situation: either Greece gets its money and stays in the Eurozone, or it doesn’t and it leaves. As we have said before, although a Grexit would unleash a wave of uncertainty into the market, now could be as good a time as any to cut Greece loose, because:
- 1. The ECB has embarked on QE: This could protect the rest of the currency bloc from excess volatility in the event of a Grexit.
- 2. Contagion has been limited so far: Even though Greece’s position within the currency bloc is probably the most vulnerable it has ever been, other peripheral nations have been basically unaffected. Spanish and Italian bond yields continue to trend near their lowest levels ever.
- 3. Growth: The latest PMI data for February, released earlier on Friday, showed the service sector in the Eurozone is picking up strongly (particularly in France and Germany), which helped to push the Eurozone’s composite PMI for Feb back to its highest level since mid-July.
We believe that a deal to extend Greece’s bailout will trigger a relief rally in the EUR and euro-based assets. If there is no deal, but another meeting is scheduled for some time next week, then the market could focus on the next deadline.
Imagining Grexit, again…
- The real market fireworks could come if there is no chance of a deal and the Eurogroup and co. make plans for a Grexit. Below are our thoughts on how this could be managed and what to expect:
- The Eurogroup makes the announcement that Greece is going to leave the Eurozone; we expect this announcement to come after the US market close sometime after 2200 GMT on Friday.
- If this happens, then we would expect the Greeks to announce capital controls on all their banks and announce a number of “bank holidays” early next week, to try and manage the situation.
- Over the weekend we would expect a series of discussions between Greece and the Eurozone and another statement before the markets open late on Sunday evening.
- This statement could include a timeline for a “managed exit” from the currency bloc including a timescale for re-introducing the drachma, how Greece will pay back its debts (will they be written off?), how the Eurozone will support the Greek economy, etc.
- A plan of economic support to help Greece manage this transition.
- The ECB is likely to step in to support Greek banks so that they do not immediately collapse.
We believe that the Eurogroup and co. will want to manage this process in the smoothest way possible to ensure that excess volatility does not hit the financial markets and disrupt the Eurozone economy.
However, the consequences of a Grexit announcement in the coming days could include:
- A sharp drop in the EUR, EUR/USD could fall below 1.10 and move back towards parity.
- We could see Italian and Spanish bond yields move higher.
- A rush to safe havens like US Treasuries, UK Gilts, the yen and the Swiss franc. It could also boost the USD, which is also considered a safe haven, and could weigh heavily on risky assets like global stock markets.
- A sharp and devastating sell-off in Greek stocks and Greek bonds (pushing bond yields through the roof).
- A sharp increase in the cost of Greek debt insurance.
- Protests on the streets in Greece (75% of Greek people wanted to remain in the currency bloc when polled before Greece’s January elections.)
- Possible public protests in Germany if Greece’s debts are written off.
The market view: We have come up with a few scenarios and our view on potential market outcomes.
No deal for Greece – the can is kicked down the road again: This could trigger a small sell-off in the EUR and in European stocks, but the market would most likely focus on the next deadline.
No deal for Greece – Grexit on the cards: This would be the most risk-averse announcement, see above for potential market outcomes.
Greece secures a bailout extension: This is the most risk-positive outcome. We would expect to see the EUR and European stocks rally; Greek assets could also outperform.
Overall, the Greek situation remains changeable, and the outcome of today’s Eurogroup meeting will be pivotal. Interestingly, EUR/USD is still moving in a relatively tight range as we moved to the end of the London session. Although volatility in EURUSD has started to pick up, it remains below the Greek election high in January. We think that the market may be too complacent about the risks of a Grexit in the coming days. If a Grexit is announced over this weekend then we could see large gaps in the markets when they reopen on Sunday night London time. We think that the market may be too complacent about the risks of a Grexit in the coming days, and there is a chance that volatility could jump, so make sure that you are prepared.