While the Santa-rallying markets have been suspiciously sanguine in the aftermath of the failed Greek presidential election on Monday and the ad hoc vote scheduled for late January which could - if left unchecked - lead to an unraveling of the Greek bailout and the expulsion of Greece from the Eurozone, events are now in motion that would end with the unwind of the world's biggest and most artificial currency and political union. In fact, the bond market is already starting to sniff out what the next, and well-known, source of contagion may be, when earlier today the probability of a Greek default jumped and, now suggest a 66% probability of default.
That said, the melodrama involving the mutual assured destruction of Greece and/or the Eurozone is nothing new, even as the debate has been raging for years who actually has the upper hand: Greece, which knows it has unlimited leverage because a Grexit would likely lead to a violent selloff in peripheral bonds, a loss of credibility of the ECB and ultimately, disollution of the Eurozone, or Europe, which is the source of all the Greek funding.
This came to a head earlier today when one of Merkel's closest advisors explicitly told Greece it can no longer blackmail Europe. In an interview with Rheinische Post newspaper published on Wednesday, Michael Fuchs who is a senior member of German Chancellor Angela Merkel's party, said Greek politicians could not now "blackmail" their partners in the currency bloc. Yes, he used that word. From Reuters:
"If Alexis Tsipras of the Greek left party Syriza thinks he can cut back the reform efforts and austerity measures, then the troika will have to cut back the credits for Greece," he said.
"The times where we had to rescue Greece are over. There is no potential for political blackmail anymore. Greece is no longer of systemic importance for the euro."
The remarks are the clearest warning yet to Greek voters from a senior German politician that Athens might lose support if it flouts the terms of its 240 billion euro EU/IMF bailout after early elections next year.
We shall see who has all the leverage in just under a month when Greece votes, and when the leading contender and most likely next Greek prime minister, the anti-bailout Tsipras, calls Europe's bluff.
However, even if Greece does remain in the Eurozone, a secondary threat has emerged to the perfectly complacent and priced-to-perfection-markets, something which we first discussed in "Draghi's QE Plan In Jeopardy After IMF Suspends Aid For Greece Until New Government Is In Place." Last night it was Morgan Stanley's turn to dare suggest that the markets, which have now priced in ECB QE in the first quarter with absolute certainly, may well be wrong:
The Greek political turmoil is likely to complicate matters for the ECB’s preparation of a sovereign QE programme. The prospect of the ECB potentially incurring severe losses is likely to intensify the debate within the Governing Council, where sovereign QE remains controversial. It could also make the start of a buying programme already on January 22 even more ambitious. In addition, the spectre of default could create new limitations on any sovereign QE design.
And should the ECB indeed be forced to postpone, or even cancel QE, and the fate of the world's capital markets rely entirely on the shaky and unstable QE originating from Japan, where the BOJ is monetizing all gross JGB issuance and pushing the Nikkei higher and the Yen lower, in the process crushing the bulk of the Japanese economy, then watch as perfectly-priced markets realize perfection never exists, not even under central-planning. Or rather, especially under central planning.
So what else did Morgan Stanley say, because what it did say will soon be aped by all ther strategists?
Here is the full note.
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Implications for the ECB and Its Preparation for Sovereign QE, by Elga Bartsch
Even though my colleagues, Daniele Antonucci and Paolo Batori, do not expect the ECB and the National Central Banks (NCBs) to be subject to haircuts in the event of a Syriza-led debt restructuring, this is unlikely to be clear-cut for some time to come. As a result, the Greek political turmoil complicates matters for the ECB and its preparation of a sovereign QE programme.
In my view, a sovereign default in the eurozone and the prospect of the ECB potentially incurring severe financial losses is likely to intensify the debate on the Governing Council, where purchases of government bonds remain highly controversial. This could make a detailed announcement and the start of a buying programme already at the January 22 meeting look even more ambitious than it seemed. The spectre of default does not only make the issue of sovereign QE less certain again than the market believes, it also could create new limitations in its implementation.
One of the decisions that the Governing Council will need to take is whether to include the two programme countries (Greece and Cyprus), the only ones that are not investment grade at the moment, in its sovereign QE. In our view, it is unlikely that the ECB will deviate from the conditions imposed in the context of the ABSPP and CBPP3, i.e. the countries need to have under a troika programme (and the programme needs to be broadly on track). This would mean though that for some eurozone countries, sovereign QE would become conditional – just as OMT was.
If governments across the eurozone and the financial constructs they are backing with off-balance sheet guarantees are being haircut and the resulting losses start to show up in national budgets, the political opposition to sovereign QE might increase materially. In fact, elected politicians in creditor countries might have a preference for the ECB taking a hit as well given that the Bank has considerable risk provisioning that could absorb these losses which national budgets don’t have. This debate could also materially influence how a sovereign QE programme by the ECB is structured, notably on whether the risks associated with such a programme should be shared by all NCBs.
Even ahead of the latest developments in Greece, the Bundesbank was already pushing for there not being risk-sharing in a sovereign QE programme. This position is unlikely to only relate to Greece though, I think. It is much more likely to relate to the concerns voiced by the German Constitutional Court regarding the implicit fiscal transfers between countries in the event of purchases of government bonds. In the view of Court, this could amount to establishing a fiscal transfer mechanism that is outside the ECB’s mandate. Once the European Court of Justice (ECJ) has given its view on OMT in early 2015, the German Court can start to work on its own verdict regarding the legality of OMT and SMP purchases under the German Constitution.
Another issue the German Court has taken issue with in the context of OMT is the fact that the ECB has indicated that it regards itself as being pari passu with private investors. Faced the prospect of a sovereign default in the eurozone where it suddenly becomes very relevant where an individual creditors sits in the waterfall of liability management, the pari passu question might need to be revisited again by the Governing Council. Whether current market enthusiasm for sovereign QE would simply ride out a renewed debate on the pari passu question remains to be seen.