Greece Is Back To Its Roots, Democracy Will Dictate

The ship has finally sailed. The Grexit is not a tail risk anymore and the market is aggressively pricing in the Greek default and a dangerously forthcoming exit from the Eurozone.

The markets opened on a severe risk-off sentiment as Greek PM Tsipras announced bank holiday, capital controls and referendum on bailout on July 5th. Following the bank run over the weekend, the cash machines are running out of liquidity, long queues in ATMs and gas stations witness the overall panic. No withdrawals exceeding 60 euros are allowed per day. The country is in deep coma.

As the ECB keeps the ELA unchanged, Greece is facing further agony in severe illiquidity conditions. Greek stock markets and banks are expected to stay closed for at least another week.

What the EU has not understood is that asking the same question several times would not change the answer. Greece does not want to pay debt by debt. The IMF payment is due on June 30th and will perhaps be missed. It is time to see if tightening the rope around Greece’s neck will do any good.

Good news is that Greek citizens are given the choice. Greece is back to its roots, democracy will dictate.

The European equity futures are aggressively sold-off this morning: DAX -3.0%, CAC 40-3.2, IBEX -3.50 at the time of writing.

In the Eurozone’s sovereign market, the spread between core and periphery is widening sharply as the safe haven flows feed into the German bunds, as well as to French, Swiss and the UK debt. Euro gapped down at the open. EUR/USD hit 1.0955 before jumping back to 1.1112, EURGBP bounced from 0.69889. High volatility trading is the main theme.

At some point in game, the ECB will certainly need to step in the market and reassure the periphery - watching with scared eyes - that this is not a one in the eye, that the situation in Greece is unique per se and that there is no need to panic or to extrapolate deeper meaning out of a potential Grexit. Given the panic run in the market, the ECB communication is essential to avoid an irreversible spill over the entire peripheral zone, which may place the existence of the euro in danger.

Is Greece too big to fail?

As the Grexit would be an unprecedented event, the market has hard time pricing in such a first-time event. The impact on the market is very much unknown and this is perhaps why the euro hangs above the 1.10 marker against the US dollar and 0.70 versus the pound. From a portfolio perspective, the eradication of the worst performer could only improve the expected value of the future cash flows and should therefore lift the fundamental value of the single currency. It however all depends on the severity of the exit and the costs that Greece and the EU should suffer following a potential rupture with Greece.

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Per se, Greece is not too big to fail as the market exposure to Greece has diminished significantly over the past weeks. The main risk is contagion.

It is a certainty: the Greek exit can only hurt the entire Eurozone in the short-run due to the lack of visibility, higher volatilities and the erratic capital flows. Depending on costs and benefits of a Grexit, the others will have the choice to take it or leave it.

This is a crucial test for the euro.

It’s bad but it could be worse.

It’s difficult to find a bright spot amidst all the calamity and panic, and the macro calendar events today will likely have little or no impact on market moves. Headlines will be the key driver for now.

Markets are off the lows however with a combination of short covering and mixed views on what exactly will materialise this week. The DAX is now off by 3%, the CAC down 3.61% but the FTSE appears to be outperforming for now, shedding a mere 1.5%. Financials are, as one would expect, under significant pressure. UK banks have fallen by an average 2% in early trade.

The euro has all but filled the gap from its close on Friday evening against the greenback and peripheral bond yields, while elevated, are not as dastardly as say back in 2012.

Gold, the usual safe haven play had dashed higher by $10/oz to $1188/oz but has since reversed the gains and now sits at $1178/oz. USD/JPY, generally bid in times of ‘risk off’ is higher by 0.8%, but again it seems the markets are waiting for some confirmation.

The jury for some is out on whether a Greek referendum will actually take place at this point. Does the market volatility help Tsipras’ case or does it erode whatever sympathy or support that might have been there.

Spain’s flash inflation number was better than expected. Prices rose 0.1% better than the 0.1% fall expected. UK mortgage approvals in May were under that of consensus, printing 64.4K against 68.8K expected. The pound had traded below the 70p marker against the euro (2007 lows) but seems to be stabilising above this metric. Likewise the greenback, sterling is oscillating around the $1.57 level.

Later sees pending home sales for the US. A monthly rise of 1.3% is expected. Much lower than the 3.4% in the prior month.

The Dow Future fell below the bottom of the June range last night but has recovered and is now trading back above the 17,700 level. We are calling it lower by 162 points.

Once America wakes up, it could all change.

Written By: London Capital Group