Euripedes would be proud. Greek Tragedy has once again taken center stage, driven by the foibles and political intrigues of its cast of characters in the same tradition that only a classical Greek playwright of old could appreciate. Heroes and protagonists may still be in doubt, but the spotlight has already panned a few individuals that have convincingly portrayed the clash that occurs when tormented sensitivities and irrational impulses must fatally collide with the world of reason. Greece is broke, refuses to change its “living beyond its means” behavior, and its creditors are leveraging for advantage.
We may only be in the third act of this five-act play, but things certainly heated up over the previous weekend. A critical deadline came and went. Greek authorities shut down the banks in the country, for fear of a run on what little capital remains in those institutions. The potential for a Greek exit, or “Grexit”, from the EU is top of mind again and press pundits are chafing at the bit, acting like vultures circling the latest road kill and looking for the most clever twist that no one else has written about. Let’s just accept for now that this article is meant to inform, not pander to the latest ratings wars.
The fate of the euro and the balance of power in Europe are at stake. Even though the economy of Greece falls somewhere between that of Alabama and Louisiana, the real issue is one of contagion. In other words, if Greece falls, then how much longer until Portugal, Spain, Italy and…One’s imagination can quickly scour the geography to determine that the Mediterranean states, the weaker members in the EU, are having a difficult time dealing with the economic power brokers in the northern Germanic states. What has the impact been on the euro? Let’s take a look:
This 4-Hour pricing snapshot was taken Monday morning and is quite revealing, if only for a moment in time. Stocks typically form “gaps”, due to news that transpires after a market close. Gaps occur less frequently, if at all, in the forex world. In this case, the news over the weekend was not good. Greeks lenders, primarily the IMF, ECB, and EU, refused to grant an extension to this Tuesday’s loan payment deadline, and then the recently elected Greek Prime Minister, Alexis Tsipras, called for a national referendum on July 5 on the EU proposal.
When forex markets opened on Sunday afternoon, the euro “gapped” down. For the EUR/USD pair, the gap was roughly 170 pips. Gaps usually are an over reaction by the market, which leads to a general market rule that gaps are typically “filled” following the dramatic move, if not immediately, then slowly over time. This so-called “fill” prediction appears to have taken place by the time this pricing picture was snapped, but the reasons may surprise you.
Remember the Swiss National Bank (SNB) and the Swiss franc Debacle, the one where the peg to the euro was unceremoniously dropped without any forewarning? Without the peg, millions in euros were soon fleeing to the nearest safe haven -- the Swiss Franc. The SNB got so concerned this morning that it decided to intervene in the market, which meant selling Swiss francs for euros and for dollars. This increased demand has been responsible for the sudden re-fill of the euro gap. In fact, the forced buying has continued unabated and the euro actually ran back up to 1.125 on the USD, only stopping to take a breather at the 100-EMA red line on the chart.
As a side note regarding appropriate trading strategies, the euro represents a familiar pattern for a currency where market expectations for a major move can cause predictable things to happen. Open interest positions are still over 130K contracts on the negative side of the ledger. A meaningful number of these bets will get edgy as the weekend approaches, for fear that a “gap” may occur on the following Monday. In anticipation of extra Euro buying before the Friday close, there is usually a predictable bump up in buying that occurs 1-2 hours before the London close. Watch for it and win.
What happened to get us to this point with Greece and the EU?
Greece received a bailout package in 2012, after devaluing existing bonds by 75% and agreeing to a number of policy changes that would rein in the reckless spending habits of the Greek government. Greek debt now stands at € 323 billion. The Eurozone, through a number of its own bond issues, owns 60% of that figure. The IMF and ECB have another 16%. Foreign banks own only 1% directly. The participation by foreign institutions is in another form. They are busy holding and trading securities issued by the Eurozone that make up the European Financial Stability Fund or the all-inclusive “Other”.
In the last few years, austerity measures have not gone down well. Debt-to-GDP ratios have barely budged. Government employment and benefit plans need to be drastically curtailed, if any substantial progress is to be made. Trade unions also refused to cave in. Greeks were irate and used the ballot box to express their anger at unemployment rates over 26% and austerity, in general. They elected Tsipras and his ragtag Syriza Party to power, after these neophytes to public governance pledged an end to austerity. In other words, Tsipras cannot agree to the new bailout terms without violating his campaign promises. It is also unclear whether other Syriza party members would agree at all.
And so, the die was cast. In a moment of political confusion, Tsipras grabbed for the only gambit open to him – Put the EU deal up for a vote from the Greek people, with, of course, his urging that they vote “No” on July 5. For all concerned, voting “No” would be tantamount to approving an exit from the Eurozone, something that world leaders have claimed would end the global economic recovery and send financial markets into an horrendous nosedive. Greece and Portugal, originally socialist states before admission to the EU, would most likely default. Europe could absorb these losses in stride, but if Spain or Italy joined the list, then all bets would be off, the feared “contagion” scenario.
What is the core issue that stands in the way of a solution?
It would take decades under any agreement for Greece to right itself, if they must do it all by themselves. The core issue has to do with a basic inconsistency in how the benefits of the euro experiment are shared. The Eurozone consortium in its present day form is not the first attempt after WWII to aggregate the economic power of the region into a single political entity. The last fifteen years have been a success, up to a point. No matter how you slice it, however, different European countries have held grudges for centuries. A deep level of distrust persists, leading to suspicion at every turn.
Germans are disgusted that the productivity of their workers is twice the average for the rest of EU members. They view many of the other members, especially the Southern ones, as lazy slackers that prefer to party down, rather pay their own way. If Germany were not in the EU, the Mark, their original currency would conservatively be 30 to 40% higher in value than the euro. As a result of the lower-valued euro, Germany has reaped the benefit of increased exports, at the expense of the Southern states, as a group, and has refused to share any of this largesse. Germans opposed the creation of the bailout European Financial Stability Fund for this very reason, but they finally conceded.
What will happen in Acts 4 and 5?
Act 4 is when the hero is supposed to go through a lot of soul searching and agony before the ultimate dénouement, which occurs in the last act of the play. Tsipras is on record asking for a “no” vote on the referendum. He claims that the lenders do not want him to lead the country and that all he wants is “to be within the European framework but with more justice. They will not kick us out of the Eurozone because the cost is immense.” To the contrary, German Vice Chancellor Sigmar Gabriel said the vote would unequivocally be a "yes or no to the Eurozone.”
EU leaders across the region have been actively warning Greek citizens that a “No” vote would mean that they have chosen to leave the union. Inflation, devaluation, default, and a host of other dire consequences would ensue, if the rhetoric is to be taken at face value. The Greek people may not be listening. They have more pressing problems at the moment, like paying rent and buying food. Banks and stock markets will remain closed for another week, with tight restrictions on withdrawals, said to be € 60 a day. As 74-year-old Anastasios Gevelidis put it, “What can I do first with 60 euros? I owe 150 just to the pharmacy.”
Concluding Remarks
Will the referendum take place next Sunday? Will Greece exit the EU? Will contagion reign throughout the region? As I said earlier, we are only in Act 3 – more suspense to come. UBS is one bank that has revealed its thought process going forward, when it comes to near-term valuations of the Euro. They have assigned a 40% probability for both a “Grexit” and “Contagion”. They claim, “The layers of uncertainty involved make an ex-ante guess of the probability of Grexit a very tricky task. Dissecting the different layers of uncertainty, however, helps us compute what we consider to be a reasonable probability of the event: 40%.” Well, at least it’s not 50/50.
Traders continue to short the euro in droves. We do not hear any shouts that parity with the greenback is on the horizon. As was seen with today, the road will be bumpy. The SNB acted forthrightly today. Other central banks may choose to follow, as well. If there is anything certain in this milieu of uncertainty, it is that volatility will be the name of the game. Volatility means that opportunity will be present around every corner for going both long and short. Sharpen up your trending and ranging forex strategies, and do fasten your seatbelts, just in case the turbulence becomes extreme.