Europe's Stress Scenarios And What Goldman Sees As Priced In

Tyler Durden's picture

Exit from the Euro would be very painful for Greece. Cut off from the ECB’s liquidity facilities, the Greek banking system would face collapse. And, as foreign lenders cut their credit lines to Greece and depositors struggled to extract their deposits ahead of the banks’ failure, the Greek financial system – and with it the Greek economy – would seize up. Given the costs of exit for both Greece and other Euro area countries, a powerful incentive exists for the two parties to reach a compromise that permits continued Greek membership of the Euro area but in the meantime the pan-European game of chicken continues and with each iteration of this game, the political cost to the two parties involved has increased. Goldman sees three key scenarios from this: Muddle Through (this is their 'Goldilocks' base case and implies continued Greek EMU membership, and ECB funding for Greek banks, but also continued pressure on Greece to reluctantly implement reforms while at the same time the remaining Eurozone countries very gradually deepen their policy integration) - which is modestly positive (though likely more range-bound) for equities and bonds with weak growth and Fed QE3 potentially pushing EURUSD up to 1.40; a Fast Exit (the least likely and most bearish scenario with Greece walking away unilaterally potentially knocking 2 percentage points of Euro-area GDP - even assuming substantial central bank counter-measures - and if the firewall were ineffective, a Euro-unraveling and an associated double-digit fall in Euro-area GDP); and a Slow Exit (Greece excluded once firewalls are in place - with pan-European deposit guarantees now front-and-center as opposed to simple banking bailouts to avoid the now-critical bank-run's contagion - which constitutes modest GDP impacts and compression in risk premia - and appears to what the market is discounting as likely).


A Slow Exit with a modest 1% hit to Euro-area GDP appears to be priced in

And the impact on the SXXP (Stoxx 600 broad European equity index)...

Current SXXP pricing appears to be pricing for a 1% drop in Euro-GDP.

A fall back down to the 2009 low of 159 in the SXXP would be consistent with GDP contracting by around 5% to 5.5%. A fall back to the pre-LTRO low at the end of last year, 215 on the SXXP, would be consistent with the market pricing Euro area growth of around -2.5%.


The Scenarios

Scenario #1: Muddling through


In the most likely scenario, the new Greek government emerging from the June 17 election neither chooses to exit the euro nor agrees unconditionally to implement the existing EU/IMF programme. This will lead to a cessation of troika payments, but would not of itself constitute Greek exclusion from the Euro area, provided Greek banks continue to enjoy access to ECB facilities. Such a scenario is consistent with our forecast for European macro variables and asset prices.


At the same time, there will also be (slow) progress toward deeper policy integration (financial market and banking regulations, fiscal coordination, and ex ante risk-sharing), in order to build the firewall necessary to make the Euro area resilient to a possible future Greek exit. In this scenario, the very large insurance premium priced into US Treasuries and German Bunds should gradually dissipate. Equities would likely rise, but initially only modestly given the continued weak growth picture.


Scenario #2: Fast exit; Greece walks away


Were Greece to unilaterally exit and introduce its own currency, the ECB would presumably halt the flow of Euro liquidity to Greece. Greece would be cut off from capital markets, forcing the government to a primary cash balance. The knock-on dislocations to the real economy could lower Euro area GDP by up to 2 percentage points, even assuming that robust counter measures are taken by the policy authorities. Our expectation would be that the policy response would be substantial. The hit to earnings expectations would likely push the SXXP down to 225, although uncertainty could push the ERP even higher (from 8.7% currently), pushing the SXXP back to at least the 215 low of last September or more and 10-yr rates to as low as 1.5% and 1.0% in the US and Germany respectively.


Scenario #3: Slow exit; Greece is excluded


There is no legal mechanism to force Greece out, but in practice it would be possible de facto by denying Greek banks access to ECB facilities. We see this as less likely than #1 but more likely than #2; it is more market friendly than #2 being a more “managed” exercise. Most likely, peripheral countries’ would have received assurance that the ECB will intervene in bond markets to limit contagion preventing a sharp widening in spreads. The likely hit to GDP of up to 1% is already discounted in equities although uncertainty may result in an initial overshoot. If the policy response was powerful, we could see a strong rally from any lower levels.



Upside and Downside Risks Relative to the Base Case

In summary and in the worst case, further substantial EUR weakness is possible, including against the Dollar in scenarios where Greek exit cannot be ring fenced effectively. This could be due to a lack of time (Scenario #2) or simply because the European institutions fail to prepare well enough (Scenario #3). In most other scenarios a gradual rebound of the trade weighted EUR is likely after some temporary decline. With regards to EUR/$ specifically, we continue to think that the US balance of payment situation exerts gradual downside pressure on the USD, and hence contributes to the stabilisation of EUR/$. Any sign of a non-disruptive solution, in particular as part of Scenario #3, could lead to a rapidly declining risk premium and hence EUR strength. In that case even our 12-month 1.40 forecast in EUR/$ may be too timid. But this is not our base case. In the base case we expect range-bound behaviour of the Euro in the near-term.


Simply put CB counter-measures are assumed to save any dramatic downside unless Greece surprises unilaterally.

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lolmao500's picture

Meanwhile in Kansas... are we in Kansas anymore??
The nonpartisan Legislative Research Department has estimated that the act will reduce Kansas government revenues by $4.5 billion over the next six years.

Income of professionals — such as doctors, lawyers, architects, and accountants — practicing in partnerships will be tax-free. In a law firm, for example, the partners will pay no tax, while the clerical staff will continue on the tax rolls.

Income received from partnerships and trusts will be tax-free. Wealthy Kansans who own real estate, stocks, bonds and other investments will simply transfer those assets to a partnership or trust, thereby freeing all their investment income from tax.

All income of farmers will be exempt from tax.

Who will still be paying Kansas income tax? Only three groups: 1) employees, 2) some retirees and 3) individuals whose investments are so modest that they cannot afford to create a trust or partnership to shelter their investment income.

Colombian Gringo's picture

Europe is about to implode and usher in a world wide depression, and you write about unfair taxes in Kansas? Who gives a fuck about Kansas except for  dorothey's and sheep f@ckers.

Colombian Gringo's picture

Naw, they are just ordinary stupid yanks who think that Bin laden is gonna rape their daughters.  Meanwhile, the real perverts are the TSA weirdos who cop a feel from their 3 year old boy.s  They  deserve to suffer for their dumbness.

THX 1178's picture

Do you really think Europe is going to implode? I do too!

Joe The Plumber's picture

I am an american and i dont deserve to suffer for their dumbness

I have enough dumbness I brought on myself to suffer. Dont need extra

yabyum's picture

employees+some retirees+ the rest = >90%. That wont fly. 

Honey Badger's picture

Scenarios #1 and #3 are the same, except for timing.

Sudden Debt's picture

There's actually also a Scenario #4!


it could happen....

Cognitive Dissonance's picture I a Muppet and thus should be following Goldman's "advice"?

I sense something way up my ass controlling my every movement.....but I thought that was the IRS.

Joe The Plumber's picture

The Muppet Masters

New movie by Robert Heinlein

Goldman Genetically engineers a butthole parasite that crawls up your ass and forces you to buy goldman products

SheepDog-One's picture

The Vampire Squid locked onto the face of humanity SPEAKS!

Joe The Plumber's picture

What a funny game

The Greeks are pulling out their euros and hiding them under the mattress while germany keeps sending more euros and runs a huge target 2 deficit

I guarantee the greeks dont want no Y series notes

Olympia's picture


Germans plunge Europe into a new Medieval Era. Are they ready to take that risk ? It was Germany that took huge loans from the American FED. It was Germany that put the markets up to buying ownership shares of the European Central Bank, which has burdened the States with sins. It was this State that lured the rest of the Europeans into a dissolute life so that it can pass the burden of its debts, hence its own sin to them. The current epidemic of debt crisis has begun from Germany, it is just that it kept its disease a secret and at the expense of everybody else, and now that it is in a better shape, it has gone hunting in order to take advantage of the disease it itself had created. The first State to have sickened has gone hunting for the one who was most weak in dealing with the disease, and that was Greece. If Germany had not been over-indebted, the European states would have never been vulnerable to the markets’ attacks.  If Germany had not been over-indebted the European states would have never been forced to mortgage their existence so that Germany’s bosses can get their money.


The Eastern gates of Europe at risk: How Northern Europe shoots itself in the leg

Authored by Panagiotis Traianou


Joe The Plumber's picture


I was lured into a disolute life.

The loans! The loans! How could I pass them up?

(you sir are the worst kind of deadbeat. The one everyone laughs at)

Olympia's picture


So, now that some unruly Northern European suggest Greece to sell its islands at a bargain price, they will not like it if that actually happens. They will not like it because selling the islands is not only about selling land where rooms to let will be built. Greek islands have multiple uses and can serve as parameters in various kinds of games. Instead of selling, the Greeks could rent land on the islands. It is the same as with the Chinese Shipping Company Cosco that has an interest in the port of Piraeus and the German construction company Hoch-Tief that has taken over control of the airport in Athens.

Can anyone imagine the geopolitical implications if we rent part of the island of Kythira to the Russians for a hundred years, for example? To what extent would the balance of power change in Eastern Mediterranean if the Bear set its foot in the Aegean Sea?  To what extent would the balance of power change if the Russian fleet dropped anchor permanently there? To what extent would such a naval base influence the defense of the unruly Northern Europeans? It would be a base that among other things could commit Russia to provide Greece with help in case the Turks challenged the Greek sovereignty in the Aegean Sea and anywhere else there are Greek interests.

So, there is a question posed to those who love accounting. How many hundreds of billions of Euros is a naval base worth in the middle of the Aegean? How many hundreds of billions of Euros do the Europeans make because Greece provides for their defense as well? Who is the deadhead in this case? Is it Greece which provides its aircraft carriers or The Netherlands that chips in a few crates of beer for the common defense? Things are simple. Until now, the Europeans could play it smart by paying a pittance. They know Greeks will protect their interests even if it means dying, so they hide behind these interests to pay a pittance. What will happen, though, if the Greeks decide to follow their example? What will happen if the Greeks decide to pay a pittance and they hide behind the Russian interests, which are anti-European by nature?


Joe The Plumber's picture

Dont sell

Default and leave the euro

That is the best option. Dont whine about it. Just do it

Fuck the banks

Olympia's picture

I can only agree with you! 

If the Europeans crush Greece financially, they pose a threat against their own existence. If Greece’s defence mechanism collapses, Israel will not last a week in the Islamic landIf the Greeks stop having interests in the Balkans, the Turks will sport about in Vienna. During some quiet nights one can hear Kosovo being blood-stained to the strains of Viennese violins. Greece is the one who keeps all these away from the doorstep of the civilized States.

Europe gives its fights every day in the troubled waters of Eastern Mediterranean, not in the calm canals of Amsterdam. Can the ill-tempered, racy Minister of Finance in Holland, who exercises the imperialism of cheese and beer in a safe Europe, estimate how much it will cost Holland as a State if Greece is substituted in terms of Europe’s defense? Can the disheveled, little madam, that scolds Greeks and pretends to be the Minister of Finance in Austria estimate how much it will cost her unarmed country if the extravagant Greek defense collapses? Will the Dutch or Austrian citizens put foreign flags on Aegean islands ever again? What business will they have to visit the Aegean ever again?

Day_Of_The_Tentacle's picture

As you clearly have a vehement disdain for these "unruly Northern Europeans", why is it that you have so far put so much europatriotic effort into defending their territory and existence?

I truly hope that your sentiments, as described in the above posts, but particularly in the linked document, are not shared by the majority of Greeks, because if they are, I am afraid that you will very quickly find that any sympathetic sentiment towards the Greeks and towards finding lasting solutions to the problems at hand, would have entirely evaporated.

The document in the link, is simply the worst piece of hate inciting, divide and conqueresque religious propaganda and malicious demagogy, I have seen in a long long time.

I, for one, do understand, that seeing a veritable barage of very negative press and flamingly disrespectful comments about ones country and people, will make a proud national very angry and bitter, and I hope that a combination of cooler heads and warmer hearts will prevail.

Olympia's picture

We are absolutely certain that it is an inevitable situation since Europe does not tolerate the north-european way of doing. They had a perfect plan but unfortunately if it lacks practical value they cannot go far with it. They have deprived Greece of every wealth and left it emaciated, left it to die in their hands. Now that they have conquered it with their money they will lose it simply because they cannot keep it alive. The plan was perfect but the draught animal has died and together thousands of people have committed suicide.


All these people can be sure of one thing only. They are not done with this. They are not done with the Greeks. You do not hunt witches so recklessly, because they might be actual witches.

Day_Of_The_Tentacle's picture

Is there no question in your mind about the role of Goldman Sachs, and the politicians, who entered into those debt swap agreements for instant mutual gratification and most likely also personal gain at the expense of your people?

You seem to lump an awful lot of people into your definition of who is to blame for this travesty, none of whom seems to be from Greece and many of whom had no part in these dealings. Do you not acknowledge any share of the responsibility for how things have turned out?

I believe it is true, that when an economy is struggling deeply, that one should be very careful not to apply too ambitious and harsh austerity requirements, because it will just enhance the troubles, and it is painfully clear that the requirements were too harsh in the case of Greece.

The people that you are squarely aiming your anger at, and who have put these harsh counter requirements into place did so, because the original agreements entered into and promises given were not honoured by Greece. Do you see no fault in that?

In any case, I sincerely feel sorry for your loss. It is sad to think of those people, who lost hope, and I hope that better days will come your way again very soon.

SheepDog-One's picture

I'm gonna submit my bid as a Greek 'firewall builder', I'll charge $5 billion for the contract, I wonder how that will go?

lolmao500's picture

EU troika deal on Greece : Traité De Versailles 2.0.

Alexmai's picture
War Imminent! BREAKING INTEL: US Top General Threatens US Military Attack on Syria. War Game in Jordan Cut Short to Prep Invasion of 12K Special-Op Troops!!

12,000 troops from 19 countries training under U.S. leadership on Syria’s borders (in Jordan) for conflicts in Iran or Syria. CNN


papaswamp's picture

....and here I thought the rumor de jour was US Special Ops in NK.

Byte Me's picture

I'm surprised Goldman hasn't proposed a Corexit solution

(Obviously with BP paying conveyancing costs)

RobotTrader's picture

Biggest opening gap up in EEM, FXI, and EWZ I've seen in awhile.

Yet I can't find any news to cause such a pop.

Sudden Debt's picture

Did your mom and dad gave you back your computer privileges?


Stax Edwards's picture

Lot o chatter about china easing (which has of course been denied by the chinese)

papaswamp's picture

DXY, Gold and stocks all rising....say what?! We seeing an outright panic run out of Europe?

GMadScientist's picture

Time to put in a bid on a castle or two...

TheTwoJohns's picture

What DAA PHUCK???!?!?!

IPC stock index gains 0.6%

--Optimism over Greece, China lift sentiment

--Mexico's peso strengthens against the U.S. dollar

MEXICO CITY (Dow Jones)--Mexican stocks opened higher Tuesday as anxiety eased about Greece and the euro zone, generating some risk appetite among investors. 

Where it eased?? peso strenghten vs usd while eur usd flat.. WTF..
such a stupid comment imo.. 

boiltherich's picture

Ireland votes on the EFSF day after tomorrow and it will be interesting.  I came across this at CNBS and it made me wonder why our intelligensia and leaders can't speak the same truths in plain language.

“In contending that the fiscal treaty will solve our dilemma, the European Commission and European Central Bank are pissing down Ireland’s back and telling us it’s raining,” David McWilliams, one of the country’s best-known economists, wrote in the Financial Times Tuesday.

Go Dave, pissing down our backs indeed.

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