What Could Greece Troubles Mean for the Euro? Substantial Volatility.
- The threat of a Greek sovereign debt default has grown significantly on lack of progress
- Fears of a default may be self-fulfilling as investors flee Greek banking system
- Volatility seems nearly guaranteed ahead of critical dates between April 9-16
Greece is fast running out of cash as it negotiates a third bailout with the Euro Working Group, and the stakes are as high as ever ahead of critical deadlines next week. What are the major risks? And why should traders control position size and leverage across Euro pairs?
Volatility Risk is Substantial as Greece nears potential default, exit from Euro Zone
If Greece fails to secure additional bailout, it will run out of money and go into default—likely forcing it to exit the Euro Zone and causing great disorder across financial markets. Estimates vary, but we view the risk of a Greek default high between the period of April 9-16.
Near-term Timeline Highlights April 9-16 as critical Period
April 9 - Greece is to pay €460m to the IMF under terms of first bailout agreement.
April 13 – €1,400m of short-term Greek Treasury Bills mature, forcing Greece to roll over into new debt but clear uncertainty surrounding debt negotiations makes strong investor demand unlikely.
April 16 – Another €1,000m of Greek Treasury Bills mature.
April 9 is a key date as the Greek government is to repay €460m to the International Monetary Fund under the terms of its 2010 bailout agreement. Missing this payment would push the government into default and likely cause great disorder across FX and broader financial markets.
German newspaper Der Spiegel quoted Greek Interior Minister Nikos Voutsis as saying that Greece could skip its payment to the IMF on April 9 in order to pay domestic salaries and pensions. A subsequent Reuters report said that the Greek government denied it would delay its April 9 payment. Uncertainty clearly reigns, and the double-speak suggests recent statements may be pure gamesmanship as it jockeys for a better deal from the Euro Working Group.
But even the threat of default could force a domestic bank run and force the Greek government to institute capital controls in the absence of a larger backstop from the European Central Bank.
Volatility Risk Grows Substantially as Key Dates Approach
The greatest volatility risk in the Euro and financial markets comes from pure uncertainty, and persistent indecision heightens the risks on a daily basis.
Key Risks on Uncertainty:
- The threat of a Greek default heightens the risks of a bank run as investors flee domestic banks.
- The European Central Bank currently provides emergency loans to Greek banks but cannot continue to do so in the case of Greek sovereign default.
- Greece likely to implement aggressive capital controls on the event it defaults in order to keep capital from fleeing the country. Fear of a bank run is self-fulfilling as risk-averse investors scramble to recover deposits.
- The National Bank of Greece showed €115 billion in assets on its balance sheet as of Q4, 2014, representing over 60 percent of domestic Gross Domestic Product (2013).
- The Greek economy could enter aggressive recession if financial system fails.
- Eventually the fear of a bank run could force a Greek sovereign debt default in itself.
What to Watch:
The Euro Working Group—the consortium of European Finance Ministers leading Greek debt negotiations—is reported to have met on April 1, but thus far no officials have commented on results of meeting. The situation remains fluid but we view the potential for headline-driven volatility as especially high.
Greek banks will be closed for a national bank holiday on April 10 and 13, and the bank closures raises the stakes for investors. The sense of urgency is thus especially high ahead of the April 9 IMF payment, and traders should monitor position risks ahead of said dates. We think that this could provide the opportunity for the Greek government to institute capital controls if it sees no alternative to default.
Euro Reactions are Far from Predictable
Derivatives show 1-week Euro/US Dollar volatility prices have risen near-multi-year highs ahead of the key dates, and risks are almost certainly to the downside ahead of a key week ahead. Yet we would also argue that much of the threat has already been priced-in—further EUR losses are NOT guaranteed.
If we get closer to key deadlines without a clear solution, increased risks will likely make for illiquid FX market conditions as banks are unwilling to provide liquidity amidst systemic risk in EUR pairs. In effect this means that the Euro could both rally and fall sharply on any news headlines.
We caught a preview of what illiquid conditions can do to the Euro/US Dollar as it surged by over 400 points in under two hours following the recent US Federal Reserve interest rate decision. If “worse” truly turns to “worst” and the Greek government looks likely to default, the Euro could see substantially larger moves than what was seen post-Fed.
Any surprises could force substantial market moves, and traders should limit trading leverage—particularly in EUR pairs—ahead of the key dates.
--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com
Contact and follow David via Twitter: https://twitter.com/DRodriguezFX
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.