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Goldman's Best Single Idea For Hedging "Grexit" Risk

Tyler Durden's picture




 

With reports of near mutiny in Syriza's ranks amid the back-bending they have done to try to meet Germany's demands - only to be abjectly denied by a non-ultimatum-setting Schaeuble - it is perhaps time to prepare (ahead of tomorrow's apparent "G" day) for the possibility that Greece creates a systemic event. As Goldman recently warned, there are aspects that leave us more worried than we have been since the start of the Euro area crisis with a tight schedule to avert a disorderly outcome. Risk markets so far have traded in a resilient (well managed) manner but risks of an accident remain and here is how Goldman suggests you hedge that exposure.

 

Via Goldman Sachs,

  • Greece tensions escalating amid resilient markets

Greece and its Euro area counterparties continue to work within a tight schedule to avert a disorderly outcome. Our base case remains that some new accommodation will eventually be found between Greece and the European authorities. But risks of an accident remain. Even if an agreement to extend the programme is reached this week, the gap between the demands of the Greek side and the programme requirements is very large.
 

  • If tensions turn systemic, EM assets likely to see pressure

Even as Greek concerns have escalated, risk markets have so far traded in a resilient fashion, treating those concerns as effectively isolated to Greek assets. But in previous episodes of acute Euro area stress in 2010 and 2012, a wide range of EM assets came under pressure, especially CEE FX and CDS. Hungary was the hardest hit across all asset classes.
 

  • To hedge Greek risk, long $/CEE

Among EM, $/CEE has seen the largest moves in times of Euro area stress. This has reflected a weakening EUR and EUR/CEE moving higher. Specifically, the HUF and PLN are likely to depreciate against the USD in the medium term as policymakers welcome weaker currencies in the fight against ‘lowflation’, and would move even more rapidly if Greek risks do become systemic. Locally, the entry levels are also attractive given the rally in EUR/CEE in recent weeks.

*  *  *

Hedging Greek risks in EM assets

Euro area sovereign and financial risks rising again
The nearly constant barrage of headlines reporting comments from Greek and Euro area policymakers is indicative of the renewed deterioration in sovereign risk. Greece and its Euro area counterparties continue to work within a tight schedule to avert a disorderly outcome. Our base case remains that some new accommodation will eventually be found between Greece and the European authorities. But risks of an accident remain as commercial bank deposit outflow and a shortfall in tax collections can precipitate a critical situation in the interim. Even if an agreement to extend the programme is reached this week, the gap between the demands of the Greek side and the actual programme requirements is very large.

The situation is fluid, and if an agreement is reached quickly to extend the Greek bailout, then broader asset markets (including in EM) should stay largely unaffected. But we continue to receive questions on how EM investors can consider hedging the risks of a more messy outcome – that either leads to a ‘no man’s land’ where Greece is without the funding that comes along with a programme or, in the worst case, an outright exit from the common currency. In these latter outcomes, with systemic risk likely to increase, EM assets would come under pressure.

Three weeks ago, we described how in previous episodes of Euro area turmoil, on average EM bond yields tracked the move lower in G3 yields as demand for safe assets spiked, whereas EM credit spreads widened, EM FX weakened versus the USD and EM equities came under broad pressure (see ‘Taking one step back’, EM Weekly: 15/03, January 29, 2015). That said, both EM and G3 bond yields are now at much lower levels – which makes the argument for being long EM fixed income more debatable in the current context. In this EM Weekly, we drill further down within EM FX, CDS and equities to evaluate the relative performance across countries over those previous episodes to help identify how best to protect portfolios against an escalation in Greek risks.

 

The EM asset experience in the 2010 and 2012 episodes of Euro area stress
Even as concerns around the extension of the Greek programme have escalated, risk markets have so far traded in a resilient fashion, treating those concerns as effectively isolated to Greek assets. But in previous episodes of acute Euro area stress, a wide range of EM assets came under pressure as risk traded poorly. Below we study the two previous episodes of Euro area stress in 2010 and 2012 to assess how different EM assets were affected on average. Euro area stresses were also elevated in 2011, but in that episode it is harder to distinguish between the impact of the Euro area worries and the US debt-ceiling crisis, which played a major role in roiling markets.

Starting with EM FX, Exhibits 3 and 4 show the average moves versus the USD and the EUR over the two periods when Euro area stresses were at their most acute: mid-April to early June 2010 and mid-March to early June 2012. Exhibit 3 shows that in these ‘risk-off’ periods, almost all EM currencies depreciated versus the USD. In relative terms, the largest average depreciations were recorded in the Central and Eastern European region (PLN, HUF, CZK), followed by a couple of the high-yielders (RUB, ZAR) in the European time-zone. The MXN and BRL were most affected in the LatAm region, whereas NJA currencies outperformed.

Most EM currencies appreciated versus the EUR (Exhibit 4), which is unsurprising given that the Euro area was the epicentre of the shocks at these times. But, notably, the CEE-4 currencies saw meaningful depreciations versus the EUR, even as the EUR itself was depreciating. The geographical proximity and the strong trade and financial linkages of the CEE region to the Euro area meant that currencies there have tended to bear the brunt of Euro area crisis episodes.

Turning to EM CDS, we find some similar patterns (Exhibit 5). On average across the two episodes, Hungarian 5-year CDS saw the largest widening (170bp), followed by a smaller but still significant widening of about 100bp in Poland and Russia, and then by the rest of the high-yield complex. Again, NJA CDS spreads in general were the least responsive to Euro area risk. Within EM equities (Exhibit 6), Russian equities were the hardest hit, with nearly a 25% decline, and CEE equity markets were also more negatively affected than the rest of the EM complex. The outperformance of NJA is less stark in this case, with a number of major markets, including China (H-Shares), Hong Kong (HIS) and Taiwan (TWSE), all seeing double-digit percentage declines.

Setting these moves in credit and equities in individual EMs against their historical sensitivities to benchmark DM indices suggests that in the past there has been more idiosyncratic pressure in the credit space relative to equities. Exhibits 7 and 8 show that, whereas the relative pressure across EM local currency equity indices is more straightforwardly reflective of the historical sensitivity to the S&P 500 index, the relative EM CDS moves are more idiosyncratic. In other words, the relatively large movers here –such as Hungary, Poland and Russia – offer a more targeted and less market-dependent way to hedge Euro area risk.

Taken together across all three asset classes, Hungary was the hardest hit, while the rest of the CEE and Russia experienced a similarly strong negative performance overall in their asset markets through these periods of heightened Euro area stress.

$/HUF and $/PLN weakening our preferred ways to hedge Greek risks
At the current juncture the market appears to be making a couple of assumptions: first, that the ongoing disagreements between the Greek government and the Eurogroup represents the typical political posturing that has tended to take place in advance of eventual eleventh hour agreements; and, second, that in the event that agreement cannot be reached by the end of February, the upgraded EU toolkit, including the OMT and the soon-to-be-initiated sovereign QE, will keep market pressures from spilling over into the rest of the EU periphery, and by extension into the broader market.

Our read of the situation is less sanguine on both counts. An eventual agreement between the Greek government and the Eurogroup is still our base case, but we worry that the gap between the current programme on offer and what would be acceptable to a majority of the Greek parliament is very large. In addition, market pressure has often been the forcing variable in the past in helping to close this gap, so paradoxically the absence of broader market pressure is likely to make an eventual agreement that much less likely. In the event that an agreement cannot be found, and ‘Grexit’ becomes a serious possibility, we would expect systemic concerns to affect markets more broadly than currently. As Francesco Garzarelli discussed (in Global Markets Views: ‘Systemic risks posed by Greece set to peak at month-end’, February 17, 2015), even if peripheral bonds are shielded from the fallout by the ECB’s purchases, we would expect the EUR and stocks to come under downward pressure, and credit spreads to widen, reflecting the downside risks to a fragile economic recovery in the Euro area.

Given the results documented in the previous section, our preferred way to hedge these risks would be through long $/CEE positions. In previous episodes of Euro area stress, the combination of the EUR moving lower versus the USD and EUR/CEE moving higher has meant that $/CEE has tended to see the largest moves across the EM FX complex. Even setting aside Greece-related risks, our forecasts call for EUR/USD to move to 1.11, EUR/PLN to weaken to 4.22 and EUR/HUF to weaken to 320 in 6 months, as policymakers in these economies welcome or actively seek weaker currencies in their fight against ‘lowflation’. This implies that the HUF and PLN are likely to weaken against the USD in the medium term based on macro and policy considerations, and if Greece-related risks turn systemic, the weakening is likely to be even more rapid. Finally, given the rally in EUR/HUF and EUR/PLN over the past three weeks, locally the entry levels are also much more attractive.

 

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Thu, 02/19/2015 - 22:41 | 5806431 Self-enslavement
Self-enslavement's picture

Print money. There is no law enforcement for the Chosenites, so the Federal Reserve counterfeiters are going to continue their crime spree.

Thu, 02/19/2015 - 22:55 | 5806457 Dame Ednas Possum
Dame Ednas Possum's picture

...until someone lights the match that burns this pile of paper, promises, lies and deceit to the ground.

Thu, 02/19/2015 - 23:27 | 5806519 flacon
flacon's picture

Just wait until you hear on CNBC that it was "free market capitalism" that failed - "capitalism failed just like communism failed in the USSR". You will blow a gasket I'm sure. Why do you think I don't watch that TV show... it's because I can't think of a more painful way to die a slow death than to hear delusional pricks with power trying to tell me what to do - sort of like the police

Thu, 02/19/2015 - 22:57 | 5806459 philipat
philipat's picture

The Squid should know, having created the problem in the first place?

Fri, 02/20/2015 - 04:22 | 5806962 Ghordius
Ghordius's picture

and the Vampire Squid Firmly Attached To The Face Of Humanity now targets the HUF and the PLN for speculative bets that have little to do with their national economies

though times ahead for small currencies. anybody still wondering why the EUR? then you have not been paying attention

Fri, 02/20/2015 - 08:36 | 5807238 game theory
game theory's picture

The squid definitely was involved in this Greece mess...doing ugly deals masked as currency trades in 2001...trying to do even uglier deals in 2010...and heaven knows how many other deals before and in between.  If this is a game of "blame the drug dealer or the addict" I think there is plenty of blame to go around.

Thu, 02/19/2015 - 22:40 | 5806434 Yen Cross
Yen Cross's picture

 If the fart exits my right cheek , what are my odds of developing flatulation?

 The Squid is docked with a huge hook in it's beak... No One knows<>

Thu, 02/19/2015 - 22:42 | 5806437 Jack of All Trades
Jack of All Trades's picture

There will be no Grexit.  Just like the Fed will not raise rates.  Don't believe the hype and spin.  Greece has to have loans.  They are doing a good job of getting some concessions but will cave in the end.  The Fed is Lucy holding the football for Charile Brown.  Those who think they are seriously going to raise rates this time will fall on their ass!

Thu, 02/19/2015 - 22:54 | 5806455 pragmatic hobo
pragmatic hobo's picture

fed will raise rates because walmart is going to raise wages from $8 to $9 and that will cause massive inflation.

Fri, 02/20/2015 - 01:35 | 5806783 The Shape
The Shape's picture

lol Walmart raises wages. They'll just cut back hours enough and crack the whips to make the serfs work harder.

Thu, 02/19/2015 - 22:45 | 5806442 Arius
Arius's picture

Goldman trying to scare people ... take the other side of the trade

Thu, 02/19/2015 - 22:47 | 5806445 swmnguy
swmnguy's picture

Hold on--to hedge against turmoil in Greece, invest in Hungary, Poland and...Russia?

Are these guys pulling our legs?  Or are they on mushrooms?

Fri, 02/20/2015 - 00:10 | 5806637 TheRideNeverEnds
TheRideNeverEnds's picture

No its simple really.  You see to hedge the risk of your levered long equity position get more long some other stuff; maybe some equities, with leverage of course.  

 

 

Thu, 02/19/2015 - 23:02 | 5806474 Yen Cross
Yen Cross's picture

 ComeOn, I can make x,.Y axis charts of my burps.

 No One knows how to predict anything. Predictions are a way of offering comfort to investors.

 Predictions are akin to reading "tea leafs". The Fed has been reading the "tea leafs" for almost a year.

Thu, 02/19/2015 - 23:25 | 5806518 Irishcyclist
Irishcyclist's picture

Your near mutiny statement is baloney.

 

If the Greek opinion polls are accurate support for Syriza has increased throughout since the election result. This suggests that their negotiating policies with the EZ enjoy more electoral support than they did at election time.

 

 

Fri, 02/20/2015 - 00:08 | 5806634 sidiji
sidiji's picture

IMO a greek exit is a positive catalyst now that europe has managed to remove banking contagion risk by putting the entire greek debt in the hands of institutions who dont really give a damn about it one way o the other.  This may have been a legit concern in 2011...now greece is just another cyprus.

 

Unlike the former banks holding greek paper, now its the ECB and IMF and EU...Greece had better be careful...countries have been occupied in past for failure to repay debts...and the EU is very very big and getting bigger every year.

Fri, 02/20/2015 - 01:22 | 5806767 Niall Of The Ni...
Niall Of The Nine Hostages's picture

So Goldman is long the non-euro currencies of CEE? And the forint no less?

So much for their propaganda about Victor Orban being a Putin in traininf just because he wanted communists brought to justice.

Fri, 02/20/2015 - 02:04 | 5806823 spekulatn
spekulatn's picture

Fooled by Randomness 

Fri, 02/20/2015 - 04:42 | 5806977 anonymice
anonymice's picture

Surely everybody knows by now that advice from GS is toxic?

If you see "Goldman" on top of a document, don't read it. Give it to your mother in law.

Fri, 02/20/2015 - 08:20 | 5807147 BolshevikPartyP...
BolshevikPartyPlanningCommitee's picture

Tae Goldman Sachs....that looks familiar.....where did I see that before???  That's it, the big currency swap swindle of 2002   http://www.realjewnews.com/?p=482

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