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The Euro has not priced in a Greek Exit

 

Greece and its European lenders have been at odds for so long that the currency markets are ignoring the possibility of a Greek exit from the euro.

In the past two months the euro has gained nine percent against the dollar and eight percent versus the yen. Such euro strength would not be possible without an almost ironclad market assumption that there will be no Grexit.

If Greece defaulted on its debt and abandoned the euro, voluntary or not, the financial and currency dislocation that would ensue would be unprecedented. The economic, financial and popular fallout from a euro exit, despite assurances from European political leaders, is unknown.

No European country has ever defaulted in the modern world. The uncertainty that would sweep the financial markets as the ramifications played out would be so high, and the unforeseen consequence so unpredictable, that traders and investors would flee the euro in droves. The obvious and appropriate analogy is the bankruptcy of Lehman Brothers in the fall of 2008.

European peripheral bonds would plummet and interest rates surge, German and alike securities and the dollar would soar and volatility and safe haven trades would dominate the markets.   

Perhaps the sheer impossibility of calculating or hedging the consequences of a Greek exit has kept the markets from pricing it in.  It also guarantees that if it does happen, the shock will be that much larger and the adjustment that much more rapid and violent. 

The Greek government of Alexis Tsipras has said repeatedly that they want and expect to stay in the euro and that desire is backed by the overwhelming opinion of Greek voters. The Europeans have also, mostly, said the same.

The markets are taking them at their word. Apparently believing that the hard line positions on both sides are just negotiating ploys. 

News reports today recounted that Greece came close to defaulting on a 750-million-euro ($855-million) payment to the International Monetary Fund (IMF) last week.

Despite warning the IMF that they could not make the payment without European help, Greece managed to find the funds by tapping 650 euros on deposit at the fund.  Those funds are supposed to be repaid within 30 days. 

The renewed concerns of an IMF default, had triggered a sell-off in Greek bonds, with the yield on two-year bonds climbing more than 250 basis points to 23.68 percent.

To put that rate into context, at the height of the European debt crisis in 2012, the yield on the Greek two year bond topped out at over 300 percent.  

Greece has relied on cash from the European Union and IMF to pay its bills since  2010.  But almost all of the 240 billion euros loaned to the Athens in the past four years have gone to pay interest on prior debt. Very little has gone into the Greek economy or made its way to the population as assistance.

Current negotiations with the EU the IMF and the ECB are solely focued on unlocking the last tranche of aid from the final bailout, worth 7.2 billion euros. 

Yet even if Greece manages to secure this last dollop of aid and avoid an immediate default, it will need another bailout in the near future.

The Greek economy cannot generate the cash to pay its interest bills and retire its debt as it comes due. Sooner or later the remaining Greek sovereign debt will be written down or written off.

The entire rescue effort has been aimed at preventing default until it can happen gradually and hopefully unremarked, with the least amount of market dislocation. It is a wish with little basis in reality.

Traders should remember the promise of another European official, Jean-Claude Trichet, the president of the ECB in the summer of 2008. He assured the world that the Eurozone would not be affected by the subprime mortgage crisis then raging in the U.S and the bank raised its main refinacing rate on July 3nd. 

Not long after Mr. Trichet's promise the reality of the financial crisis brought on a 23 percent collapse in the euro in just over three months. 

The 20 percent decline of the euro over the past year has had scant to do with Greece. It has been based largely on the anticipation and then reality of the ECB quantitative easing program and prospective rate hikes from the Fedreal Reserve

The market assumption that Greece will remain within the euro is not only becoming more problematical, it is almost wholly unpriced. 

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Charts: Bloomberg

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