Greece Is The Word

 | Jun 22, 2015 05:55AM ET

•Greece is the word All eyes will be on Greece today as the deadline for reaching an agreement approaches. Greek PM Tsipras will meet with the leaders of the three international creditors (the EU, the ECB and the IMF) today ahead of a summit meeting of EU leaders. He reportedly presented new proposals over the weekend, although the details were not available and the FT reported that no formal written proposal had arrived. The Greek newspaper Kathimerini said that at the EU summit, Tsipras will be presented with two options: either accept the reforms proposed by the creditors, potentially with some Greek amendments, or prepare for a default. If Tsipras is willing to compromise, the creditors would probably extend Greece’s bailout program and perhaps make a commitment to discuss debt relief. The paper said that “sources indicate that Tsipras could be ready to accept a compromise, with amended proposals on value-added tax and even possible pension reforms in exchange for a firm commitment from creditors on debt relief and a growth-boosting package.”

• If they don’t reach agreement today, then discussions may be suspended until Thursday, when there will be a regularly scheduled EU summit. But some participants reportedly believe that today is the “end of the road” and that if no agreement is reached, the EU will be prepared to “let them go,” according to the FT.

•Meanwhile, the head of the Bank of Greece warned that Tuesday would be a “difficult day” and that “decisions will have to be taken” if the two sides don’t reach agreement on Monday. Some EUR 4.2bn was reportedly withdrawn from the banks last week, and there were said to be orders for another EUR 1bn to be withdrawn today. If withdrawals continue at that pace, a bank holiday and/or capital controls would soon be necessary unless the ECB greatly increases its Emergency Liquidity Assistance (ELA) to the county. The ECB raised the ELA on Friday, but reportedly not by as much as the Greek central bank asked for. The ECB board is expected to discuss the liquidity of the Greek banking sector in a special meeting at 0830 GMT today. I expect them to remain supportive so long as there is a chance of a settlement. But if there is no compromise today, then the ECB could institute what has been called the “Cyprus solution:” threatening to stop supporting the banks unless the government agrees to the lenders’ conditions. That was basically what forced a settlement on Cyprus, and it could have the same effect on Greece – or it could cause the dreaded “Grexit.”

• If they do reach agreement today, I would expect Tsipras to put it to a referendum in order to get popular backing for an agreement that his party would probably object to. It’s hard to see how the politics would be carried out in time to meet the end-month deadline, but I expect that the creditors would bend the rules as necessary to give Tsipras every chance to get an agreement through.

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• Looking at the market’s response to the problems in Greece, it’s clear that investors think either that A) a solution will be reached, or B) a Greek default will not have much of an impact on other borrowers or on the private sector. I agree that a solution seems the most likely outcome, given that the failure to agree would be much more expensive for both sides, plus polls show the Greek public wants an agreement. The difficulty lies in getting any agreement through the Greek parliament. That could require a change in the ruling coalition.

As for default, most of the Greek debt is now held by governments or agencies, not by banks or investors, so there is not much reason for a Lehman Bros.-like collapse. Portuguese business confidence, for example, is almost back to pre-2008 levels, while Portuguese bond spreads over Bunds actually tightened last week. The only visible sign of distress in European financial markets has been in the equity markets’ implied volatility, where the VDAX (the German equivalent of the VIX index) is now substantially higher than the VIX. But even that is partly due to the strength of the euro, which is putting downward pressure on German stocks.

• Personally, I’m not so sure. I think a default with Greece remaining in the Eurozone would be likely to engender contagion at least to the other peripheral countries, while a default and exit from the Eurozone (which I think is much less likely) could be catastrophic for the currency union and the currency.

• Today’s indicators As for the indicators, we have a relatively light agenda. We have no major indicators to be released during the European session.

• In the US, existing home sales for May are forecast to have increased a bit. The housing starts and building permits released last week were consistent with an improving housing market. If the existing home sales are in line with a strong housing sector, this may be USD-supportive.