The Grexit: what to watch out for if Greece leaves the euro
IG analyst — David Madden
The eurozone crisis has bubbled away in the background for five years now, with the Greek situation steadily declining amid the ever-looming prospect of the nation leaving the currency union. Traders need to be wary that a Greek exit could have an enormous impact on the financial markets and many different asset classes.
To a large degree we’re in uncharted territory here. The very fact that no country has ever left the union means there’s no blueprint for Greece’s departure; neither in terms of the political process, nor the financial ramifications.
While Greece accounts for less than two percent of the eurozone’s GDP, there are some compelling reasons for keeping it within the fold. Not least to save face and retain some unity among fellow members. If the indebted nation makes a break for it, could other struggling countries like Spain, Portugal or Ireland follow them? One clear advantage of Greece staying for the rest of the member states is that it keeps the currency artificially low.
Orderly vs disorderly exit
It is not just a question of whether Greece leaves the euro, but also how it is handled. An unexpected and sudden announcement that Athens is going it alone would send shockwaves through the eurozone and further afield. And that’s precisely why it is not likely to be conducted in that manner. This style of Greek exit would lead to low risking taking by traders, and assets that are perceived to be safe would be in demand.
If Greece leaves the currency union in a controlled and orderly fashion, the market would experience a jump in volatility at the very mention of it, and dealers would initially take a low risk stance. But if the move is drawn out over a number of months (and it is clear that only Greece will be leaving the eurozone) confidence will return in the medium to long term, with traders taking on more risk as the dust settles.
There is no doubt the single currency itself has taken a hammering since the Greek debt crisis began. The euro has come under pressure repeatedly during the various Greek bailouts and when other countries had to be rescued during the sovereign debt crisis. But while other bailed-out nations got on with imposing austerity measures and restoring some confidence, the dire Greek situation kept holding the euro back.
How the currency reacts to a Greek exit all depends on the handling of the ordeal. The initial fear would be that this could be the end of the currency union, and panic selling could ensue. However, if the European Central Bank manages to reassure investors that Greece is the only country exiting the currency area, the euro could push higher as it will no longer have the weight of the Greek problem pulling it down.
There will be external pressures as well. The US hasn’t ruled out an interest rate hike this year, and that will put EUR/USD in the spotlight. The Bank of England is also looking to raise interest rates next year, followed by a likely jump in trading volumes for EUR/GBP. Wary traders will need to keep an eye on EUR/JPY as well. Although the yen is seen as less of a threat to the euro even with a Grexit, set against the bigger quantitative easing battle between the Bank of Japan and the ECB.
If Greece were to leave the eurozone it would be like a financial earthquake for stock markets, with those closest to the epicentre suffering the most, but further afield none would fully escape the effects. The eurozone equity markets have benefitted greatly from the ECB’s QE policies, and the decline from the May highs would be significantly accelerated should Greece decide to leave. The ramifications would ripple through Europe, across the Atlantic and on to the Far East. Dealers have a way of selecting the wheat from the chaff, and some equity markets will fall more than others. The core eurozone markets like the Germany 30 and the France 40 will be hit first. The UK may not be in the currency bloc, but it is its biggest trading partner, and in turn the FTSE 100 will also feel the ripples of a Greek exit.
As the Greek debt crisis has been chugging along for five years, banks in the eurozone have gradually reduced their direct exposure to Greece’s debts. The German financial system alone has €15 billion worth of exposure to Greece, but the majority of that is held by a state controlled bank. Publically-listed firms like Deutsche Bank and Commerzbank have €298 million and €400 million worth of exposure respectively. By the end of 2013, France’s BNP Paribas still had €700 million worth of Greek debt on its books. Credit Agricole has the same level of exposure.
However, the sector might not be quite out of the trees just yet, particularly if we see a disorderly exit. If confidence in the region’s banking system is falling, all the finances houses will feel the effects. Funds have been flowing out of Greek banks and the country at a fast rate, and that cash flight will only pick up. Traders would be paranoid about a contagion throughout the eurozone, still fearing what dark asset secrets the banks might have on their books. The credit crunch saw a number of banks go to the wall, and the eurozone debt crisis saw a few countries bailed out. Greece’s exit could trigger a similar round.
The metal is considered to be a safe-haven investment, and during times of uncertainty it’s always going to be in demand. The all-time high for gold was reached in 2011, when the eurozone debt crisis drove traders out of the equity markets and into lower-risk assets like cash, high-rated government bonds and gold. When the US lost its triple-A credit rating in the summer of 2011, gold was propelled to a record high. Despite gold losing some attractiveness since, a similar historic event is bound to send demand for the metal soaring.