Although it has been a quiet start to what should be a very busy week in the financial markets, there has been quite a bit of volatility in the EUR/USD. Between the Asian and early European trading session, the EUR/USD fell nearly 100 pips on concern that little progress was being made on Greece. Since then, the EUR/USD has recovered nearly all of its losses and is at the brink of turning positive for the day. The details out of the EU Finance Ministers Summit has been slim but in principle, Germany, France and the ECB have agreed that voluntary rollover of debt is the way to go. There is no question that it will be a challenge to convince bondholders to rollover their debt but with the right terms, it could happen. Investors are also hopefully that Greece will receive its fifth bailout tranche in a timely fashion. European leaders are also stocking up ammunition in case another country like Spain needs to tap the fund. Klaus Regling, the head of the European Financial Stability Fund announced this morning that the EFSF Guarantees will be increased from EUR440B to EUR780B.
However the gains in the EUR/USD should be limited because the communique from the EU Finance Ministers meeting also said additional aid will be contingent on Greece passing austerity measures and unfortunately political troubles in Greece will make a deal very difficult to achieve. Greek Prime Minister George Papandreou’s no confidence vote will be held on Tuesday and even if he survives the vote, the Greek government still needs to sign off on the measures needed to secure a deal and avert a default. At this point, there is too much political infighting to make that a smooth process and it is very unlikely that any meaningful progress will be achieved by the end of the EU Summit which means the Greek Tragedy will continue into July, leading to more volatility in the EUR/USD. As a result, it will also be a challenge for the EUR/USD to hold onto its gains in the coming days.
What if Greece Defaults?
A default by Greece also remains a risk for the EUR/USD. If the talks fall apart, leaving Greece with no choice but to default on part if not all of their debt it could tip off a global financial market sell-off almost as bad as Lehman Brothers. We may have known about the Greek crisis for some time now but sovereign defaults are extremely rare and when it occurs, it creates panic and losses for investors around the world. If the EUR/USD is trading at current levels when a default is announced, a break below 1.40 will be quick and bloody. Yields in Europe would spike higher, leading investors to look around for the next victim. The financial markets could freeze up as banks lock down credit and panicked investors unload all risk assets by selling everything from stocks and bonds to high yielding currencies. The bonds that will be hit the hardest are those of Portugal, Ireland, Italy and Spain. The biggest beneficiaries will be the U.S. dollar, Swiss Franc and other safe haven currencies. Gold will also rise sharply because at the end of the day fiat currencies are nothing than pieces of paper. Yet before getting too dismayed, it is comforting to know that the world has survived sovereign defaults in the past (Russia in 98 and Argentina in 01) – but only some serious carnage.
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