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The curious case of the euro

The escalation of Greece’s flirtation with default and Eurozone expulsion was curiously not reflected in the euro.

Euro notes
Source: Bloomberg

In fact, the EUR/USD ended last week higher against the greenback, which begs the question of what is going on? Is this some market positioning play before trouble hits the fan? The proverbial calm before the storm?

This week will bring an emergency meeting on Monday to finally throw up a deal that Greece and its creditors can at least compromise on, for the time being.

There is talks of a ‘definitive’ solution, but I will not hold my breath. Even if there is some form of an agreement, the longer-term issues of Greece’s debt sustainability and weak growth still need loads of work, discussions and compromises.

In the meantime, political posturing is not going to help, and may actually be counterproductive.

Back to the curious case of the euro resilience. The immunity of the euro to the Greek crisis is a marked departure of how it has behaved in the past when there is a stalemate in previous bailout aid talks.

I think there are several reasons why this is so. Firstly, much of Greece’s debt (some €320 billion) is now owned by sovereigns, and not the private sector. This means that deterioration in Greek assets do not automatically transmit to more downward pressure on peripheral European assets.

Secondly, the current stand-off seems to stem from a political well, rather than a financial problem, which should not have an adverse long-term impact on EUR-based assets.

Thirdly, out of the so-called PIIGS nations (Portugal, Italy, Ireland, Greece and Spain), only Greece is in a worse fiscal and economic position than it was in 2010, which suggests a significantly lower contagion risk.

Lastly, the anti-austerity government backdrop in Greece is not replicated across other PIIGS nations, so there is less chance for unhelpful political posturing.

Of course, the resilience of the EUR does not mean the market is not vulnerable to the Greek crisis risks. While the spot market is relatively stable, there has been increased activity in the options markets.

The EUR/USD one-month volatility has been on the rise since the start of the year, leaping to 14.0, highest since late 2011.

This suggests that traders are hedging their bets. If you compare the EUR/USD one-month volatility with the six-month implied volatility for EUR/USD, the former is consistently higher than the latter for much of this year. This is interesting because you would normally associate a longer-term volatility of any asset to be higher than a shorter-term one because we cannot predict the future.

So what this means is that while the market is worried about a Greek bankruptcy and exit from the Eurozone in the short term, in the longer term, they actually don’t really care so much if Greece is cut loose. The market is simply not pricing in a disaster for the euro and appears sanguine that the single currency will stay resilient in the future, with or without Greece.

What’s going on this week?

China watchers will be gritting their teeth to see if the sharp correction from last week will carry over to this week. However, they have to wait until Tuesday as Chinese markets are closed on Monday for a holiday. Liquidity has played a huge part in last week’s plunge, with the volume-weighted interbank 7-day repo moving up 66bps.

This also raised talks of more PBOC easing to stabilise the liquidity crunch, specifically another reserve requirement ratio (RRR) cut. On the data front, flash China PMI will be closely watched on Tuesday.

In Japan, I will eye BOJ monthly economic report for June, while PMI numbers (due on Tuesday) and inflation reading (due on Friday) will be key Japan data to look out for. Meanwhile, it is also good to note the US durable goods orders (due on Tuesday), Q1 PCE deflator, Michigan consumer sentiments, as well as Eurozone PMIs and consumer confidence reading.

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