Update: Greece votes no to Europe, now for the moment of truth

<p>So Merkel and Hollande have decided not to go it alone on Greece and instead have called a leaders summit now that things are getting […]</p>

So Merkel and Hollande have decided not to go it alone on Greece and instead have called a leaders summit now that things are getting serious in Athens.

From a market perspective, it looks like the EUR has broken through 1.10, but is still only likely to open down 1%, while the German Dax is down some 3.5%.

These movements are roughly similar to those that we saw last Sunday night after the referendum was first announced. This caused an initial knee-jerk reaction lower, however, price action in the days leading up to the referendum suggested that the market thought that the close opinion polls were really masking a Yes vote, and the status quo bias would prevail at the polling booth.

This was not to be, now that we know that the Greeks have voted an emphatic No to the bailout offer (subject to final confirmation from Athens, but looking likely at this stage), the market reaction looks pretty tame and does not seem to be pricing in some of contagion scenarios we have pointed out below. Thus, expect a lot of volatility from the markets in the coming days. Tonight’s initial reaction could be the tip of the iceberg and risky assets could come under sustained downward pressure in the next few sessions as the latest act in the Greek saga unfolds….

See our initial piece below.

So, the Greek polls have closed and the result is looking like a win for the No camp, which campaigned against accepting the terms of another bailout for Athens. If this early result is correct then this is the most uncertain outcome for the markets and is likely to cause the most market turmoil in the coming days.

The first official polls suggest that the No camp could have won nearly 60% of the vote, but that is with less than 10% of the votes having been counted. Either way, it looks like the Yes camp has a mountain to climb to emerge victorious from this referendum.

A win for the No camp asks more questions than it answers:

  • What will happen to Greek banks? Reports suggest that they only have EUR 500 mn in cash left… if they are left without a lifeline then surely they won’t be able to reopen on Tuesday as Tsipras promised.
  • The ECB is scheduled to hold a meeting to discuss emergency funding for Greek banks on Monday. Although Benoit Coeure, an ECB member, said last week that the ECB would continue to do all it can to help support Greece, surely upping its contributions to the leaky Greek financial sector is well outside of the ECB’s mandate. Due to this, I would not be surprised to see emergency funding pulled for Greek banks in the coming days, which would ultimately make this the final nail in the coffin for the Greek banking sector, and could send Athenian share prices into a fatal nose dive.
  • A win for the No camp also makes negotiations with Greece’s creditors substantially harder, and thus, it cannot be assumed that Greece will get any more money from the EU, ECB or IMF.
  • This makes further defaults, including on some large sums owed to the ECB later this month, even more likely.
  • Overall, those who thought the chances of Grexit were at 60% last week, must now be revising them up to 80%.

The ECB could be the first European institution to make a crucial decision that could impact Greece’s future. If it cuts ELA funding for Greek banks this week then its financial system could collapse in a matter of days. The writing was always on the wall, especially as deposit withdrawal has been so ferocious recently, however this could accelerate the whole process. This darkens the future for the Greek economy ten-fold. Without a functioning banking system, and with no decent alternative coming from the Syriza government, we expect Greece to fall into a deep recession for many years.

Should it stay or should it go? It’s up to Merkel:

The prospect of Grexit could require many more months’ of negotiations, and if Greece does leave the Eurozone we expect it won’t do so for another few years. However, Merkel and Hollande are expected to meet on Monday, which could seal the fate of Athens’ future position in the currency bloc. If Merkel decides she wants to keep Greece in, then Tsipras could be right and Greece’s creditors may come up with a less onerous plan to fund the troubled state. However, if she overrides the will of the Greek people and says “nein” to their ‘bailout without the all the strings’ request then we think that Greece’s fate could be sealed and a life outside of the currency bloc awaits.


The market reaction:

We have decided to look at this from a long and short-term view.

Short term: if a No vote is confirmed late Sunday/ Monday, as appears likely at this stage, then we would expect to see a sharp sell-off in risky assets including stocks and the EUR. We would expect to see risk aversion dominate Asian markets before spreading to Europe and the US. We expect safe havens such as JPY, CHF and USD, along with US Treasuries to surge. We would expect EURJPY to be particularly volatile on the downside. Watch the SNB, the Swiss authorities may be forced to intervene, like they did last week, to stem CHF appreciation in the aftermath of this turmoil, which could make the EUR even more volatile at the start of this week.

Even though the EUR managed to stay resilient in the face of last week’s negative Greek headlines, I don’t think that the market really thought there would be a No vote, ourselves included. However, now that Tsipras’s bluff has been pulled off, essentially Athens has the upper hand over the European authorities. We believe that this makes the EUR extremely vulnerable to speculative attack in the coming days.

We also expect a spike higher in the yields of peripheral European bonds including Spain and Italy. Any signs that Grexit is likely could aggravate this in the coming months.

Long term: We think that the biggest long-term damage could be more political than financial. To explain further, although European companies have some exposure to Greece, it is fairly small. For example, Germany, who has the largest exposure, has approx. EUR 35 bn, which won’t cause any long-term damage to German companies or the German economy. As the German body for car exporters said last week, the biggest threat to German companies is not from a Grexit, but through Brexit, and a referendum is not scheduled in the UK until 2017.

Overall, even though Grexit may not materially weaken Europe’s corporate sector, for the medium-term European stocks could struggle along with the EUR. This is because a Grexit would rip the political fabric of the currency bloc apart. We expect there to be an increase in risk premiums on the debt of other financially weak European countries such as Italy. Since there is a positive correlation between German and peripheral European bond yield spreads and European stocks, any re-pricing in European bond markets could have a long-term negative impact on European indices.

We are waiting to see how the markets will react. The other 90% of votes need to be counted, so the night is young. However, if the vote is No then expect a volatile day across all financial markets as risk sentiment dries up and investors flock to safe havens.


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