And Now Back To Europe, Which Is More Unfixed Than Ever

Tyler Durden's picture

So stepping aside from the biggest aggregator of private data for a few minutes, and focusing on what actually matters, here is Citigroup telling our European readers who have those fancy multi-colored bills in their wallets, that they are in deep trouble.

To summarize from Citi:

  • There are many scenarios for a Greek exit;  almost all of them are likely to be EUR negative for an extended period
  • Some scenarios could be positive in equilibrium but the run-up to the new equilibrium could be nasty, brutal and long 
  • The positive scenarios for the euro involve aggressive reduction of tail risk; none of these seem likely
  • It is unlikely that central banks busily substitute EUR for USD in their portfolios during periods of intense political uncertainty.

Full note from Stephen Englander

Many clients are asking us to analyze the currency implications of alternative scenarios with respect to one of more countries exiting the euro. Below we run through some of the main issues that are being discussed. We are uncomfortable with the extent to which the most likely scenarios play out negatively for the EUR, but the euro upside scenarios depend on euro zone policymaker assertiveness that has scarcely been visible recently.

Scenario 1: Managed Greek exit; no contagion or financial market disorder

This is the most benign scenario with respect to a Greek exit, assuming away the major contagion risk. There is likely to be short term euro weakness, but a sharp initial sell-off would be deceptive and the weakness would be relatively brief once the contagion fears wore off. 

Some argue that the euro would rally strongly off this development, arguing that the euro ex-Greece would be much stronger than the euro with Greece. This positive scenario would be a world in which the risk premium on other euro countries has been largely determined by the fear of contagion from a GREXIT, not issues related to other peripherals themselves. Once GREXIT occurred without damage, whether on its own or because of policy commitments, spreads would narrow and the euro would rally.

Absent such an unwinding of knock-on risk on other peripherals, the arithmetic of the euro zone divesting itself of the Greek 2% of the euro zone facing a major depreciation is not very exciting. If the new Greek currency depreciated 50% (a very round number), the implied boost to the surviving EUR with its stronger components would be about 1%, basically it’s overnight move.

The above is a very optimistic reading of what is driving peripheral spreads in other euro zone countries. If the concerns reflect risk associated with national debt in other peripheral countries, not primarily Greek contagion fears, then even if the fears abate, the fiscal concerns on remaining peripherals would prevent a major appreciation. So this benign scenario does not seem the most likely scenario by any means, nor is it likely that the euro’s problems are as Greece-centric as needed to make the euro outcome play out as described. That said, if the benign scenario plays out, EURUSD could rally significantly from current levels, trading closer to 1.45 or higher, but it just doesn’t seem very likely. 

Scenario 2: Greece exits, contagion spreads to other peripherals

Greece repudiates the austerity of bailout #2 and exits the euro zone. Contagion spreads to other peripherals.
This scenario entails months of profound economic and financial confusion during which the euro would be under constant pressure in our view. How the euro evolves depends on how euro zone policymakers deal with contagion risk and that depends on the post-departure policies that are followed.

Substantial euro downside could emerge from investor fears that other peripheral countries in the euro zone would drop out, raising the risk premium on their debt, and making it even less possible to hit fiscal and economic growth targets. A Greek dropout could be viewed as unfortunate but manageable, if the euro zone disintegration was viewed as stopping there at Greece, but the risk is that investors come to expect that other countries will follow. Such countries would experience the worst of all worlds, austerity, a risk premium that now builds in additional currency risk, but no control of exchange rate or monetary policy and no growth. Investors in that case would speculate that the cost of staying in the euro was too high for other countries as well.

The way to avoid this contagion and downward pressure on the euro would be to provide an absolute, non-conditional guarantee that no other country would drop out. This would be a spectacular transformation -- an ECB that is unwilling to act like the Fed morphs into the SNB.

Moreover, some clients have raised the possibility that investors would not believe even such a guarantee – at least not initially. They would argue that the example of Greek depreciation would induce even Mom and Pop in other peripheral countries to shift their deposits to Germany, the UK, the US or Switzerland because the downside from doing so if other peripherals do not drop out is low, and the downside from not doing so if there are further dropouts is tremendous. At a minimum this provides a big hole in peripheral banking systems that would have to be filled by the ECB – probably involving the ECB in far more open-ended risk than they have shown a willingness to take. It is unlikely that all the deposits would go to Frankfurt, so there is probably some direct downward pressure on the euro involved. The final element of the argument is that investors and residents will fear that the ECB can not bring itself to make such a permanent and potentially very expensive contingent commitment.

The EUR could begin to rally if the euro zone manages to ring-fence the other peripherals but so much damage will have been done by then that the EUR would begin its rally from a much lower level and probably not be anywhere close to the current level at the end of the year.

The optimistic view on contagion is that the ECB would not actually have to take on the risk if the commitment was ironclad enough. But if there is any degree of skepticism or if the ECB showed any hesitation, the risk-return would be in favor of capital flight and the euro would fall sharply and the ECB would face additional balance sheet risk. 

This is the problem that the euro faces on any dropout scenario, Even a small country dropout that has limited direct financial and economic implications for the euro zone could raise the stakes enormously with respect to other countries. Whether the euro goes up or down depends on whether the euro zone policymakers can bring themselves to make the needed open-ended commitment and convince the market that they will stick to it thick and thin even if the price tag rises. Given their inability to achieve timely consensus on policies that would have averted the pressures and been much cheaper, investors are likely to sell euros until fully convinced of policymaker resolve.

Scenario 3: Multiple peripheral countries exit, core remains

Our economists do not see this as a high probability scenario, but it is certainly discussed by FX investors. This is the scenario in which the likely dynamics of exit conflict the most with the long-term equilibrium. Define the long term as the point at which economies and exchange rates have moved back to their long-term equilibrium path. The euro of the surviving core will likely be stronger than its predecessor euro was. Consider that the deficit, debt and external balances will be much stronger than with the current euro. So one can make the case that the long term equilibrium value of this ‘core’ euro is much stronger, possibly even at the highs that were seen in 2008.

However, the short and medium term may last for an extremely long time and the dynamics over that period are very negative, not just for the peripherals that drop out but for the core that remains in. Consider that the peripheral countries are likely to drop out one by one, probably accompanied by economic and financial disruption. The impact will be felt on core economies and financial institutions as well, so whatever the long-term equilibrium, the path there will likely be accompanied by economic weakness at least until a stable core is formed and a path to recovery is envisioned – this can take a very long time and is probably well beyond an investible horizon. The high cost to both the dropouts and the remaining core countries is one reason that this is considered such an unlikely scenario. 

Scenarios that boost the euro.

Only the first scenario above has a euro positive component relatively quickly after the Greek exit is realized and the probability is low that investors will look as benignly on the event as the scenario implies. 

The characteristics  that each of the euro-negative scenarios share is that each reflects an augmentation of euro zone risk. Even if the risk is accompanied by a relatively hawkish ECB perspective, the euro falls because investors are focused on the deep risks associated with euro breakup rather than marginal, and probably unsustainable, gains from a hawkish ECB.. The argument we would make is that global investors will cut the euro a lot of slack if extreme tail risk can be eliminated, even if the outcome involves a bigger balance sheet or other unorthodox policies.

Scenario 4: New Greek government embraces austerity plan

We are not so naïve as to think they would actually embrace austerity, but by accepting the plan, they would relieve investors of concern in the short term of a messy default, bank runs and immediate financial crisis. Investors would not necessarily view this as a good outcome objectively, but as a better and much cheaper outcome than the alternative of messy default and Greek euro zone withdrawal. Essentially a continuation of the status quo, the question is how long a period of tranquility such a compromise would buy. If investors are jaded and view it as a very short term patch before renewed strife the bounceback in the euro would be limited.

Scenario 5: ECB bond buying or Eurobond

Both of these take a step towards resolving what is a major failure of monetary policy in the euro zone -- Interest rates are simply too high. A GDP –weighted average 10year yields of non-program euro zone countries is more than 150bps higher than in the US or UK. This effective tightness of monetary policy is hardly justified by upward inflation or growth risks.

Were the ECB to buy bonds aggressively it is unlikely that investors would fight the ECB. Were the fiscal authorities to jointly issue an Eurobond, it is likely that core yields would go up and peripheral yields down – exactly the rate redistribution required to stimulate activity in the periphery and support their asset markets. This is likely to reduce tail risk and support the euro.
Looking at these two scenarios, it seems far more likely that the SMP buying will be renewed than the governments coming together and issuing an euro bond in the near term. It seems far more likely that the trillion EUR balance expansion of the ECB since mid-2011 would have been more effective buying cash bonds than operating through the LTRO.

Having put forward these proposals, we have to admit that they seem less likely than the ECB making an effort at reviving confidence by a bog standard rate cut or an additional LTRO. The political opposition to these measures means that even though they are likely to be the most effective in resolving the crisis, they are unlikely to be the first (or second) applied.

Scenario 6: LTRO or rate cuts

It seems unlikely to us that the euro zone’s underlying problem is that the refi rate is 1% rather than 0.5%, or 1.5% for that matter. A rate cut could be seen by the market as some sort of signal that further aggressive easing was coming, but by itself it seems more likely to stimulate activity in Germany than Spain. Nevertheless, it is possible that the cut could come and that the euro could even rally if the cut was viewed as complementary to other policy actions that euro zone policymakers were planning. If the cut was viewed as a substitute for more effective measures, the euro would probably resume its fall, possibly even accelerating in its decline. To paraphrase Crosby, Stills, Nash and Young – if you can’t use the policy that works, work with the policies you have. But the euro is hardly likely to respond positively.

Similarly, a third LTRO would tread a familiar path. So far, the two earlier LTROs have eased borrowing costs at the short end and led to a shortening of duration by peripheral issuers. An LTRO with a significantly longer maturity might encourage euro zone financial institutions to buy longer dated government bonds and bring down long term interest rates.  The first two helped stabilize and reduce bond yields temporarily but now they are back to where they were in the bad old days of November 2011, although not at the very peak of the crisis.

One reason the first two LTROs did not trigger a sustained drop in peripheral funding costs was the intensifying deposit flight which added to banks’ funding issues. We suspect that a pan-euro zone deposit guarantee, funded by the EFSF or ESM, could enhance the effectiveness of any future bouts of ECB lending as it will limit the outflow of bank resources. That being said, however, so far there is not much appetite for a Europe-wide safety net with the countries of the core reluctant to bankroll bank liabilities in the periphery. Moreover, the potential losses are extremely high if any country were to leave the euro zone and any country left out would almost be guaranteed to experience significant capital flight. If it could be implemented credibly (say with an ECB backstop) then the effectiveness of LTROs would not be undermined by deposit flight and banks might become more aggressive bidders for their sovereign's debt.

Potentially this could ease strains within the euro zone and generate both a global and euro zone risk rally, but to be implemented credibly would require a similar open-ended commitment to those discussed above, and such commitment have been hard to extract from euro zone policymakers.

Concluding remarks

Approaching a second round of Greek elections potential scenarios leave the balance of risks pointing towards a weaker EUR. In the long run, while there may be more favorable equilibriums, the path there we suspect will be very painful. At this stage a mixture between scenarios 2 and 6 seems most likely, with 1 a possibility on the outside – not very promising for the EUR unless policymakers surprise with decisiveness.

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francis_sawyer's picture

Scenario 7: Printing more money will fix everything...

sbenard's picture

Indeed. Who even needs an economy? We have PRINTED prosperity now! LOL!

redpill's picture

I don't see how Spain wouldn't be anxious to follow them.  Dominoes.


Oh regional Indian's picture

F'n Bankster Fluckers, and their banker scenario/model gobbledygook.

Structured Adjustments and Haircuts my ass. The system is based on an untenable construct (war-enforced debt)... and it has a finite life.

Die gracefully, it's allowed.


GeneMarchbanks's picture

'Die gracefully, it's allowed.'

It isn't, hence this rambling, game theorizing doo-doo. The 'thoughts' of a Zombie.

So sad to see an entity outlive itself.

Oh regional Indian's picture

And the thing Gene, is that it's everywhere, fractally. Like those wizened, leathery, wrinkled rock stars taking the stage in tights and wrapped in flags at 60... or sir paul fleeeekin mccartneygetouttahereretire....

No one gives way gracefully anymore. Every old fluck can.... take the Blue Pill... and be bounced upon with the best of them.

They've essentially killed childhood and old age.... mufers...

soon everyone will be fifty for ever. Horrowshow!



GeneMarchbanks's picture

Fifty?! It ain't fifty, try twelve. The tweenification of absolutely everything is where 'they' want us to be. Dough eyed and infantile, always wanting continually needing: The Inelasticity of Demand.

Try finding people at the cemetery in the Untied pSychosis of Amnesia. You cannot go missing, it's not allowed. Truly No Exit.

Europe is different, so one can still live.

Manthong's picture

“Some scenarios could be positive in equilibrium but the run-up to the new equilibrium could be nasty, brutal and long”

I think it is better phrased:  the toilet with a leaky valve that is full of crap is in equilibrium until the handle is turned and the fierce flush produces a  toilet that is emptied, but in equilibrium.

So I’m just waiting for the “Unfixed-er” headline.



francis_sawyer's picture

 "You cannot go missing, it's not allowed. Truly No Exit."


You are collateral... chattel... That's why they want you alive... (ultimate hoarding in the name of keeping the interest payments flowing to the inbred trust fund babies... because there are never enough yachts for them to water ski behind)...

Buck Johnson's picture

This isn't going to end well and they know it.

Rahm's picture

AppleFace can't bailout this one!

OttoMBMP's picture

Have they merged already?

tekhneek's picture

$38.06 w/ 35 minutes left 'til close... Can she close green...? OR... will it be a RED CLOSE?!

Zero Govt's picture

Facebook IPO flat as a pancake

seems Goldman's lost its touch on this flopper

carbonmutant's picture

I wonder how many EU banks are long FB....

Zero Govt's picture

have they any money left to chase FB's all on deposit with the ECB no?

JailBank's picture

I have a feeling if Greece leaves the Euro will drop and the dollar will rally again stomping the PM gains again. It doesn't make sense but neither do these markets.

You'd think that if I kicked my freeloading brother out of my mother's house her financial situation would improve, but the markets will crap on the euro to run to perceived safety of the dollar.

Any thoughts?

francis_sawyer's picture

The Euro (currency) is & always has been a NWO 'poster baby' for a single world currency sought after by the banking elite families... Even though it has been a spectacular failure, they will not let it go down with a fight (same thing with that OTHER spectacular failure [THE US DOLLAR]...

Just keep stacking (& try to curtail canoeing expeditions)...

sbenard's picture

My bet is on scenario #3

kito's picture

agreed sbenard. scenario 3 will be the outcome, especially because citi's dumbass know nothing economists feel its the least likely scenario (always bet against the word of the tbtf pundits...always)..... once the debtor baggage is jettisoned from the euro, the currency will stabilize (albeit after a turbulent ride)......all piigs will stay in the european union for trade purposes, but will have their own currencies. now can we please move on to japan and the united states already......its almost as if tptb want the world to keep their eyes on europe....keep focusing on the small abrasion on your left arm so you dont notice your right arm and both legs have severed arteries........

navy62802's picture

Haha. By some accounts in the media, if the periphery were to leave, leaving only the core, we would end up with a Eurozone composed only of Germany.

lizzy36's picture

Obama (at G8)  lecturing EU leaders about need for "fiscal consolidation with growth".

Obama lecturing anyone on fiscal consolidation is really really funny.

Politicians really have no shame.

Mind you if i was Obama i would be worried.....his whole re-election is done if greece explodes. Imaging that "greece doesn't matter" narrative that dopes have been pushing for 2 years, yet the re-election of the President of the USA, hinges on this "doesn't matter" country.

carbonmutant's picture

Ah Lizzy, I was typing the same

AlaricBalth's picture

"fiscal consolidation with growth"

In todays Keynesian fueled economies, that would be an oxymoron, like Government Organization or Corporate Responsibility.

kito's picture

i dont see greece hurting obama..if anything it helps him. he shows the world how austerity destroys countries and that his spendthrift ways are whats kept the u.s. out of harms way (chuckle chuckle). he will point to romney and the repubs and say, "you see!!!! they want you to go through what greece is going through!"  and if greece does collapse, the short term impact will be a stronger dollar, lower borrowing costs as the world runs back to the last bastion of delusion....europe's mess is helping the fiscally irresponsible lunatics that run our the short term of course....till the focus is actually on the u.s...........

Harbanger's picture

Spinning events in Europe, even with full msm support is counter productive.  Obama has zero credibility among the population that actually goes out and votes in the US.   

BeetleBailey's picture

+10 Lizzy.

Obama gets away with it because;

1) The majority of the populace is naive/stupid/too busy/too busy on Facebook/doesn't care as long as they keep GITTIN their free shit/guilty of being white (strange, as he is an Arab)/watching American Idol

2) The media, controlled by the Bilderburg/Soros Death Star/More White Guilters, covers his ass more than Sherwin Williams covers the earth.

topshelfstuff's picture

I noticed all the demonstrations have been kept out of our news and TV screens coverage.

Zero Govt's picture

we don't want to encourage the peasents or give them any ideas

the US Govt, sorry US media, only shows rebellion when the CIA have sparked it to over-throw unwanted foreign Govts

carbonmutant's picture

I hear "No Budget" Obama is going to advise the EU on how to fix their problems at the G8...

francis_sawyer's picture

Maybe that's the plan... No budget...

GeneMarchbanks's picture

That's just something they put out for the plebs. In reality, the 'discussions' are about something else altogether.

Harbanger's picture

OWS was protesting Rush in Chicago yesterday.  He doesn't work/live and hasn't been there in years but the geniuses were convinced he was there.

manhunter's picture

Another US based bank bashing the Euro. Propaganda is boring, the EU is not falling apart.

GeneMarchbanks's picture

Not just any bank... Citibank. Show some respect to these perfectly solvent, profit machines you goofball.

Toolshed's picture

Dude........where can I get some of what you have been smoking?

crawldaddy's picture

LOL.  sure riots are just what?  street raves?

Harbanger's picture

In 2008, the United States government and Federal Reserve helped bailout European banks with "trillions" of dollars. 

TWSceptic's picture

"the EU is not falling apart"


keep telling yourself that, that's what Barroso and Van Rompuy are doing.

Zero Govt's picture

Barroso and Van Rompuy are "doing" precisely nothing

national Govts have taken over completely, these 2 total tools are now spare parts (powerless) as the nation States self-interest is above the EC/EU collective from hereon out

data_monkey's picture

No decisivness. It'll never happen. To quote Geithner, "political politians"

BeetleBailey's picture

...and I retort to Timmah:

Fuck You, you Fucking Fuck!

colonial's picture

Hey Tyler:

I agree with those who say the new currency for Greece should be the US Dollar!  If the Europeans are going to sit on their wallets...

Greece is the new American Samoa!  

mammoth mo's picture

So Tyler - I guess we see a rally today until about 2pm and then everyone will again realize that Europe opens on Monday.

misterc's picture

But that expat dude residing in an Asian police state (Jim R.) said that he would buy € once Greece leaves the € zone.

Trimmed Hedge's picture

Hey, so what's this whole FaceBook thing I keep hearing about, anyway...??

falak pema's picture

Move to Florianopolis, the land of honey and samba all year long. Who cares about first world.

crawldaddy's picture

if this were about Greece only, then it wouldnt be a problem.  But it is not. We have a systemic problem, and those usually arent solvable in away that keeps the system alive.

For this to be fixed, it must be allowed to collapse. ( which it wont because the rich will lose, so what we will get is another deacde or two of halfass fixes and failures and ultimately ww3. ( as populist wildcards will rise from such times)

Olympia's picture

Global Debt Crisis

The greatest private fraud of human history.
Who are the great fraudsters who are becoming the murderers of the human kind? How does the economy "illness" threaten Democracy and the freedom of people?
By knowing what happened in indebted Greece, where loan sharks created “bubbles” and the current inhuman debt, one can understand the inhuman plan in total ...understand where this plan started just to bring all states at the same end ...understand how this type of plans are established...