Forex markets primed for weeks of brinkmanship and volatility
For a country, which only accounts for about 2% of the Eurozone GDP, Greece is having an extraordinary impact on global markets. The now very real prospect of it leaving the Eurozone could have profound consequences for exchange rates and the global economy.
During Monday's Asian trading session, EUR/USD fell 2% at one point with Greece imposing capital controls and closing much of it's banking system. Greece also looks set to miss its EUR 1.6 billion repayment due to the IMF on Tuesday. Meanwhile, bond yields in Italy, Spain and Portugal shot up on Monday as investors fret over the fate of these countries should Greece leave the Eurozone in the coming weeks.
Recently, it looked as if the EUR was starting to regain some poise versus the once rampant USD. However, if Greece leaves the Eurozone – speculation will switch to which country will be next to go. This will trigger a flight to safety with USD, JPY and CHF being the beneficiaries. Risk currencies such as GBP, AUD and NZD stand to lose ground in a 'risk-on' environment and the flawed EUR most of all at the moment.
Despite Monday's sell-offs, forex and other markets don't seem to have entirely priced in the risks associated with Greece departing – there's clearly still some hope of a last, last minute deal.
A Greek departure will be read by many in the markets as a failure by the Eurozone authorities to do whatever it takes to save the EUR. Indeed, if Greece is to default it would be better for it to do so inside the Eurozone, rather than outside it, which to a large extent depends on whether the European Central Bank is to continue providing life support to Greek banks.
Default within the Eurozone would be a lot less messy and pose fewer questions over the EUR's long-term viability. Though that is not on offer at the moment – such a compromise could surface over the next few weeks, which would likely see the EUR stage a strong relief rally.
EUR/USD – it could go either way
Likely reactions to a Grexit:
– The ECB would probably step up buying peripheral Eurozone bonds and provide any necessary support to the banking systems of Eurozone countries suffering stress. If nothing else it will put off short sellers of those bonds.
– The financial fall-out from a Greek default seems less likely to effect the global banking system as many foreign financial institutions have curbed their exposure to the country and most of its debt is owned by supranationals such as the IMF and the ECB.
– Should Monday's sell-offs of equities and other risk assets turn into a veritable blood bath over the next few weeks – it could spark coordinated interventions by other central banks, namely the US Federal Reserve, to buy EUR and possibly even restart limited quantitative easing.
– Damaged consumer and business confidence is likely to see other central banks quickly loosen monetary policy in a bid to sustain GDP growth – leading to revived concerns over currency wars and competitive devaluations.
The next few weeks will be very tense and present plenty of opportunities for volatility. Both sides of the Greek debt negotiations are now playing at brinkmanship making the outcome difficult to predict. Not least the Greeks hold a referendum on Sunday over the creditors' austerity measures. A vote against them would effectively be a vote to leave the Eurozone (so far it looks like it will be a yes vote, but as seen with the recent British election results, polls can be unreliable).
By Justin Pugsley, Markets Analyst MahiFX