48-hours to save the EUR?
Another day, another headline about Greece and another crucial deadline missed to sort out its debt situation. The latest move by Eurozone finance ministers is to give the Greek government until the end of the week to come up with a solution as they failed to present any plan on Tuesday.
Don't hold your breath that this will be the end of the matter. No doubt there will be tense negotiations over the weekend, which may spill into next week. But time is running out for the country with its cash-starved banking system and economy now closer than ever to collapse.
So far forex markets have been a lot less volatile than expected on the twists and turns of the Greek drama. A key reason is that most of its debt has effectively been 'nationalised' by supranationals – namely the IMF, EU and European Central Bank. International private-sector banks have little exposure now to Greece. Also, markets are still holding out that there might be a solution.
Greece is currently requesting a third bailout in five years and needs deep debt restructuring and some easing in its austerity programme if the economy is ever to recover and potentially repay some of its debt.
EUR/USD – central banks likely want to avoid parity
Into the unknown?
Further debt forgiveness is difficult for the creditors because of the moral hazard argument. Give too much and too often – other peripheral Eurozone debtors, such as Italy, Portugal, Eire and even Spain could ask “then why not us?” should financial and economic conditions start deteriorating again for them.
Nonetheless, much is at stake for the EUR. If Greece departs it will set a dangerous precedent and greatly weaken long-term confidence in the single currency. If Greece later starts to recover and grow again with the Drachma – other Eurozone countries may start to question the need to stay in the EUR, particularly if they're still languishing with high debts and increasingly unpopular austerity programmes imposed by creditors.
Whatever happens with Greece, Eurozone members will feel compelled to carry on integrating themselves into something resembling a super-state as the only way stave-off the continuous existential questions over the EUR.
And if Greece does exit? This could happen as early as next week. It would likely unleash considerable volatility, probably more in equity rather than forex markets. It could force central banks around the world to intervene to steady the EUR, particularly if it rapidly breaches support at EUR/USD 1.4626 and even falls below parity.
On the other hand, Grexit has been so well anticipated and hopefully well prepared for, that the reaction might be relatively muted. The EUR could even recover after the initial shock (if bond yields in peripheral Eurozone countries are kept down by ECB buying) on relief that a major problem for the single currency has been removed.
Next week's comment will look at the problems with currency unions and the fact that they don't have a great track record.
By Justin Pugsley, Markets Analyst MahiFX