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    EURUSD: will the ECB save Greece?

    What a difference a few years makes. Back in 2010 and 2011 the EURUSD suffered sharp drops every time discussions over a Greek bailout decision stalled. But these days the Greek impasse has barely moved the market. EURUSD has traded in a 200 pip range for the last 2 weeks and is actually higher on Tuesday after a temporary slide post the breakdown in Monday’s talks between Greece and the Eurozone finance ministers.

    There is still time for Greece to find a deal with its creditors, however, for now it is the Eurogroup’s turn to take the hard-line. The German finance minister was talking earlier and has said that the Greek finance minister Varoufakis has failed to convince Eurogroup members that his plan will work. The head of the Eurogroup said earlier that the ball is in Greece’s court if they want to continue to negotiate. The next Eurogroup meeting will be held on Friday which is now considered the last date that a bailout extension can be agreed in time to get parliamentary sign off ahead of the 28th Feb deadline. So there is still time for the two sides to reach a deal.

    The ECB’s Greek life raft

    However, Greece’s future in the currency bloc could depend on the outcome of a meeting on Wednesday. This is when the ECB will hold a meeting to decide on Emergency Liquidity Assistance for Greek banks. Last week the ECB extended ELA funding to the Greek banking system by EUR 5 billion, however, this won’t be enough to protect the Greek banking sector from the deposit flight that is currently taking place. If the ECB decides to cut Greece lose then Varoufakis and co. may have no choice but to quickly agree to an extension to its bailout and delay negotiations for a further 6 months. Although the Greek people seem to support Syriza’s stance towards Europe, they also need a functioning banking system, so the power could be in the ECB’s hands.

    In the lead up to Wednesday’s ECB meeting a Reuters source has said that there will be “no sudden end to ECB approval of emergency liquidity for Greek banks expected this week.” So maybe the ECB won’t cut Greece loose straight away.

    Kicking the can…

    The Eurozone authorities are no strangers to tortuous negotiations that ultimately only see an extension of Greece’s bailout for 6 months or so. This is hardly a long-term solution and would leave us back in this position in early Autumn. If the Eurogroup were looking at a long-term solution then they would be looking at ways of allowing Greece to have a “soft” bankruptcy and negotiating a deal with its creditors. Ultimately Greece cannot pay back its EUR 270bn bailout loans, but this is too politically noxious to make it onto the agenda. For now a “victory” for the Eurogroup and risk assets would be a bailout extension for a few months; essentially using more debt to patch up Greece’s debt problems.

    The market view:

    Breaking it down, we see two potential scenarios for the markets this week:

    1, Greece ends up with a deal: The bailout is extended which gives Athens 6-months to grind down the Germans on the austerity and reform drive. This is likely to be EUR positive and we may see a wave of positive sentiment in the European stock market. We would expect to see 10-year Greek bond yields moderate back towards the 7% mark, the lowest level since December. We would also expect to see bargain hunters snap up Greek stocks, particularly banks. Of course, in the long-term we still face the same problem, but the markets seem to be happy to focus on short-term victories when it comes to Greece.

    2, Greece doesn’t get a deal making Grexit a real possibility: this is EUR negative, we would expect to see the single currency sell off, particularly against the safe havens like the USD, CHF and the yen, while stocks could also come under pressure. Greek assets are likely to be the worst performers, with stocks tanking and bond yields jumping past the 11.16% highs reached after January’s elections.

    Volatility suggests no panic

    Interestingly, short-term EURUSD volatility has been moderating this week, and has backed off its Jan highs, even though Greece is back on the agenda. This leads to our most alternative view when it comes to the financial markets and Greece: perhaps they just don’t care.

    The Eurozone economy has been picking up in recent weeks, Germany is doing well, the ECB has implemented QE and there isn’t any noticeable contagion to other peripheral markets. Perhaps now could be the best time for a Grexit, and that is why EURUSD volatility isn’t any higher…

    Figure 1:


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