If Greece leaves, Spain or Italy will definitely either default or threaten to leave (they've seen that bailouts in exchange for austerity don't work).
We have laid out in great detail over the past few months the contagious paths, game-theoretical endgames, and transmission channels that would occur should a nation (Greece for example) leave the Euro. Yet the covered matter is not simple, which is why sometimes the best representation is the visual one. The Financial Times has outdone themselves with the best graphical (and audio walkthrough) representation of this process. From the collapse of the domestic banking system (and its possible social implications) to the creation of a new 'local' currency absent foreign capital aid, to the obvious 'who's next?' question that leads inevitably to exaggerated bank runs across other weak European nations and ultimately more pressure on already weak economies to exit the Euro - hastening a wholesale Euro-breakup. Eurocalypse now indeed.
Earlier today we were delighted to predict precisely what the script of the European headline flow would be now that the only thing that matters is instilling the fear of Chairsatan in the Greek people, who are so confused that 75% of them wish to keep the Euro, but 80% wish for austerity to end - two mutually exclusive events. We outlined the daily event flow for the next month as follows:
- Europe releases definitive rumor that everyone is preparing for a Greek exit full of bombastic jargon and details of how Greece will be annihilated if it does exit the EMU;
- Immediate election polls are taken;
- If "anti-memorandum" Syriza support is not materially lower, rumor is promptly withdrawn for the day, only to be unleashed the next day with even more bombastic end of world adjectives describing the 9th circle of hell Greece will enter unless the Greek people vote "for" the pro-bailout parties, "for" the Euro, and "for" a perpetuation of the status quo;
We got the first confirmation of precisely this a few short hours later.
Courtesy of Reuters, we now have a handy, bookmarkable interactive chart for everyone's convenience to keep track of this data. And while we still believe the actual result will be meaningless, as a coalition government, either pro or against bailout, will be unformable, we are certain that the second we read that Syriza support is waning (one day, only to surge the next), the EUR, courtesy of its record short interest, and all related risk assets will soar. Keep a close eye on this chart.
Building on yesterday's discussion of the lack of an integrated banking system and credible lender of last resort in Europe, UBS appears to have gone thermonuclear this morning. Their lengthy article 'What If Greece Goes?' outlines the contagion risk from an 'orderly' exit as markets, international trading companies, and bank depositors will all anticipate the consequences likely resulting in economic disorder. Their remains a great deal of complacency about the ability of firewalls to prevent this - but as they note - should bank runs begin, even a pan-European deposit guarantee scheme will not stop rational depositors extending bank runs instead of gambling on the probability of policy-maker actions. Laying out Greece's options (renegotiate austerity or default), UBS summarizes the situation more profoundly: "Integrate Or Die" as without a Euro confederation (in their eyes), continental Europe will cry 'havoc' once again.
Europe's game of chicken, all of which is geared to one simple thing - to spook the Greeks into voting for pro-bailout powers, and against Syriza - has now officially entered the Twilight Zone. In the latest episode of what can now simply be described as the world's most entertaining yet terrifying mutual assured destruction showdown, because should Greece leave, the destruction, at least in the short-term, will impact both Europe and Greece, although Greece will recover far, far faster as the standard of living there has already been crushed (which incidentally is the primary reason why Europe has lost control over the situation: without the carrot of welfare state promises, a Ponzi regime is meaningless), we learn that on Monday a Eurogroup Working Group held a teleconference in which officials "agreed to prepare for individual contingency plans if and when Greece exits." Here is the problem - the contingency plan can be summarized in one word: panic. Because absent a full blown coordinated monetary intervention, Europe's individual states are completely powerless, and they know it. Sadly, and this is where the farce and charade are complete, the Greek people know it too. As a result, this little adventure, leaked subsequently to Reuters, loses all utility. But we expect many more such escalations from Europe: after all we have nearly a full month before June 17: plenty of time to crush the market in order to get a reaction out of the Greek voters, European politicians and ECB bankers, just as Citigroup suggested. Only issue is, the more Greek voters are prodded into a corner, the more likely they are to simply snap.
We have already posted this fantastic timelapse in the past on various occasions, but it is always worth putting things in Europe in their proper context, such as this 1000 years of "Old World" history summarized in 3 minutes. Many say the European experiment will end if Greece votes the 'wrong' way on June 17. Somehow, after watching the below, we doubt it.
Whether it is the EU running to the G-20, nations in Asia, the IMF or Spain and Italy and their brethren calling for Eurobonds the distinction is easily made; you pay or you pay or you pay because I cannot. That is the cry in the wilderness as politely, very politely, quite politely everyone says, “No thank you.” The curtain is going down on the show and the normal pleas are being made to keep the spectacle in operation but the pocketbooks are closed and Germany and the rest are not going to bet the family farm when the final act draws nigh. The Elves in the boulders cackle and the “invisible people” move on and sigh as the ending of one more chapter is inscribed in the Book of Life.
Following the morning in Europe, a generally risk-off tone is observed, with stock futures sitting just above session lows and the German Schatz auction resulting in record low yields. Some of the risk-averse moves were noted following unconfirmed market talk that a troubled Dutch housing association may be pressed towards bankruptcy, however this seems to be linked towards an article concerning the Dutch central bank probing into the sale of derivatives to the housing group Vestia. Nonetheless, the long end of the Dutch curve remains well-bid and European 10-yr government bond yield spreads are seen generally wider across the board. Releases from the UK have come under particular focus; the BoE minutes showed an alongside-expectations vote of 8-1 to keep QE on hold. With some analysts estimating more of a lean towards further asset purchases, the initial reaction was strength in the GBP currency, but countering this effect was the parallel release of UK retail sales, with the monthly reading showing the sharpest decline since January 2010. Additionally, it was noted that several members of the board saw further QE as a finely balanced decision, placing GBP/USD back on a downward trajectory and briefly below 1.5700. Elsewhere in foreign exchange, current sentiment is reflected in EUR/USD, printing multi-month lows earlier in the session of 1.2615, with the USD index at 20-month highs which in turn has weighed on commodities.
With only new home sales (which we actually report as opposed to NAR goalseeked marketing materials) to hit the docket in the US, the only newsflow that matters again will be that coming out of Europe, which is holding an informal summit. As BofA reminds us, the summit was originally set up to discuss growth. Now, it is there for Grexit damage control. Today's discussions will focus on the use of existing tools for supporting short-term growth. Spain and Greece are likely to be on the agenda as well. On Greece, although discussions should focus on the pros and cons of a Greek exit, we believe there will be no communiqué other than to mention that Greece should stay in the euro area and implement the programme. On Spain, discussions will likely focus on the banking sector. The discussion will likely be around using the EFSF (or its successor ESM) directly to fund the banking sector, a step Germany opposed in the past. Overall, we do not expect many decisions from the summit. Rather, we expect a communiqué about what was officially discussed, and a date for a later rendezvous. In other words, "investors are likely to be let down by today's summit" (that was BofA's assessment). Also let down, were markets in the overnight session when the BOJ, contrary to some expectations, left its QE program unchanged. As usual keep an eye on headlines: record EUR interest means violent short covering squeezes if the algos sense a hint of optimism in any red flashing text (if only briefly, as the long-term outlook for the situation is quite hopeless).
A quick look at the Fresh-Start Greek Government Bond (GGB2) complex shows that as of this morning it has tumbled to fresh all time lows across the curve, and now trades at a more than 50% loss to the March PSI conversion price. The reason for this dump is not so much on fear of a Greek exit, but once again a reflection of precisely what we expected would happen, and as explained in our January Subordination 101 post. Last week, the fact that a PSI hold out, holding English-law bonds managed to get par recovery while all the other lemmings have so far eaten a nearly 90% loss, has sparked a realization among all the other hold outs that since they have covenant protection, they should all demand the same treatment. And indeed, another one has stepped up, only this time not a holder demanding par maturity paydown, but one who has read their bond indenture and was delighted to find the words "negative pledge." As Bloomberg reports "a holder of Greek bonds that weren’t settled in the biggest-ever debt restructuring said he’ll demand immediate payment unless the government posts collateral against his investment. Rolf Koch, a private investor who says he holds 500,000 Swiss francs ($528,000) of the notes due in July 2013, argued that he’s entitled to equal treatment with Finland, which made getting collateral a condition of contributing to Greece’s second bailout. He wrote to the paying agent, Credit Suisse Group AG, invoking the bonds’ so-called negative-pledge clause, according to the text of a letter seen by Bloomberg News."
Just when one thought it was safe to come out of hiding from under the school desk after the latest nuclear bomb drill (because Europe once again plans on recycling the Euro bond gambit - just like it did in 2011 - so all shall be well), here comes David Rosenberg carrying the launch codes, and setting off the mushroom cloud.
With G-Pap talking of federalism all morning at Zeitgeist, the M.A.D. button was just pressed again by L-Pap as only minutes after we hear of a drop-in-a-bucket EFSF rescue fund for Greek banks, Dow Jones notes:
Preparations for Greece Euro Exit Considered, Papademos Says: DJ
We have not been shy to point out the potential (and now proven) flaws in the Euro experiment (here, here, and here for example) over the past year or so but UBS reminds us that while most people remain fixated on the absence of a fiscal transfer union in so large a monetary union (to offset incidents of inappropriate monetary policy) as Eurobonds and Federalism come back to the fore; it is the second flaw - the absence of an integrated banking system (backed implicitly by a credible lender of last resort) - that should be getting front-page headlines. As Niall Ferguson noted at Zeitgeist this morning, "Structural reforms will work but will not work this week" and in the meantime, TARGET2 balances grow out of control and the longer the 'problem' remains, the worse it becomes leaving an implicit infinitely supported firewall as the only interim solution. While most who foresaw the Euro as implicitly leading to federalism were right, it seems the link to a German dominance (of ECB rulings and general fiscal and monetary decisions) has been the ultimate outcome. While an integrated banking system would do nothing to change the relative competitiveness or growth issues that plague Europe, the 'essential' internal capital flows would be sustained. Is this sort of integration a realistic prospect? The politics is not especially propitious.