Default Day or the Foundation Determines Everything

On the night of June 27, Greece called a referendum on the terms of financial aid; however, Tsipras's attempt to shift the resolution of this problem to his compatriots will not have any legal force for European financial institutions.
The Greek tragicomedy is approaching an end risking to pull the key card out of the house of cards called "euro". Today, the destiny of the currency union (and not only of it!) is directly dependent on the decision of European politicians regarding this region. Last week did not produce anything positive for the Greek crisis. No one even allows to think about writing off or restructuring of the Greek debt. Creditors demand a reduction of expenditures, first of all pension payments and salaries of public sector workers that are quite disproportional for this situation, and the advertised Tsipras's plan envisages the resolution of the crisis through tightening of taxes; however, raise of taxes does not really guarantee their collection. The Sunday decision to preserve the ELA volume at the current level can be seen as the only positive.

The European Commission has not managed to reach a compromise until the opening of European markets on Monday, and the main currency opened with the gap of over 200 points, pulling the cross rate EUR/JPY after it. The market showed the most important thing: even reaching an agreement that will extend Greece's agony will not solve the problem with euro, since those agreements are yet to be implemented. Therefore, despite the complete work off of the gap at the opening of the week, the perspectives of euro lie in the range between bad and very bad.

The declared bank holidays and suspension of the Greek stock market are, evidently, a late measure. Within two previous months, billions were taken out from the banking system and the liquidity securities provided by ECB have long run out. Let's divide the results into several points:

  1. Among the perspective politicians of the new wave (such as Marine Le Pen), there is a growth of confidence that the idea of the common currency has failed; however, the structure called "Eurozone" has to be dismantled steadily and consistently. Presently, it is Greece; in 2017 - it will be Great Britain (Brexit) and France (Frexit) after the possible change of president. However, no one has still made any attempts to assess the volume and the technique of separation of problems that will arise at divorce.
  2. Dollar has got new Yellen's comments, that, in case of absence of solutions for the Greek debts, Europe's perspectives will worsen significantly and market destabilization will affect the US economy. It means that FRS will have a reason to increase interest rate in 2015 (in case of Greece's default), since Greece's pull out of Eurozone will create more problems for dollar than for euro. (Let's remember Obama's words - "we don't need a strong dollar"). The experience shows that the time lag of the European economy's influence on that of the US is about 2-3 months.
  3. The stock market analyzes reports on business (Ifo) and consumer (GfK) sentiments regarding euro: Greece's problems affected small-scale consumers. Banks suspend provision of new loans fearing that they may urgently need liquidity. Consumers in Germany and France are being careful in their expenditures now, although they produce reports on the growth of income and employment.
  4. The way the current situation will reflect on the stock market will depend on the volume of measures taken by ECB for deterring the domino effect. The market of Greek securities is ready for massive sell-offs; it applies primarily to the banking sector and fixed income securities. The yield on state bonds, including peripheral European (including Italy and Portugal) will predictably grow because of high probability of default (since investors will hastily include high probability of default into the price).

On the night of June 27, Greece called a referendum on the terms of financial aid; however, Tsipras's attempt to shift the resolution of this problem to his compatriots will not have any legal force for European financial institutions. Moreover, even the Head of European Commission was not notified of such a step - it is obvious that that was intended for some kind of "game shock". The fact that Greece transferred 50,000 euros to IMF as debt repayment looks ridiculous. Presently, IMF rules out the possibility of delay for Greece, and, even if a miracle happens and someone will pay for Greece today - the issue of default will be relevant in two weeks (dates of July payments).

For the first time, Greece had a demonstration of its citizens who came under EU flags; however, there are certainly fewer people who see their future in Europe than those who are against of the policy of saving. Nevertheless, there are those people and it is exactly them who are associated with the "European" results at the upcoming referendum. At the same time, Brussels confirms that there are no discussions at this point with regard to Greece's pull out of Eurozone. The declaration of IMF technical default takes several days, and until that moment Greece expects to get the decision regarding the national plebiscite. Greece will keep the company of Somalia, Cuba, and Zimbabwe - they have arrears in IMF debt repayment or had them in the past. Rating agencies declared that non-payment to IMF will be considered as default, but ECB will hardly dare call Greece a bankrupt. ECB's internal rules do not allow to finance insolvent banks through the ELA program; however, in order to close ELA, the consent of 2/3 of the ECB's executive Board is needed. It is difficult to gather so many similar opinions now.

Among the other events, we can note reduction of prime rate (annual borrowing rate) by the Central Bank of China starting from June 28 by 25 basic points (to 4.58%) and deposit rates were also reduced by 0.25% to 2% for 1 year. This decision is the consequence of the largest since December 1996 decline on the stock market and 4-week growth of money market rates. The response of raw material currencies to this information is still going on, we can expect further flight to safe assets, in the result of which dollar, yen, and Oceania currencies must win.

Technically: EUR/USD drop-down below the tenth figure turned out to be too emotional. On Monday, due to the growth of profitability of European state bonds by 20-40 points in average, euro was able to recover losses and consolidate at the level of 1.1200, while unfortunate JPY was still not able to rise above the strong level of 122.00/20 and its upward chances are little. From the point of view of the price, the influence of the Greek default on euro can be assessed approximately in 200-300 points from the current price (within one month), at least at levels 1.1450/1.1500 and 1.0950/1.1000 large players have not dropped their orders yet. In case of publication of weak macroeconomic data in the USA, these levels can be worked off by the common currency within a pair of weeks. Let's remember that due to the Independence Day, NFP data will be published on Thursday; Canadian non-farm will also be published separately from that of the "Big brother" - on July 10.

作者: Navsher Bartash,
ForexChief Currency strategist