Will the Euro actually rise on Greek developments?

Outlook:

The referendum in Greece proves nothing and changes nothing. Syriza is regrouping and consolidating power, Tsipras gets to keep his job, and nothing has changed within the borders of the bailout talks. We have no evidence (yet) that the credi-tors will engage in debt forgiveness and new loans, or that Greek leadership can institute needed reform.

It’s entirely possible that the FX market will accept that the Greek stand-off will persist for months and maybe years, and go on about their business trading the euro on the other factors and FX rate determinants. This means the euro can rise and fall on other news and data, and remem-ber that going in to the current default crisis, the euro was on the rise because of some decent green shoots in Europe combined with really bad data out of the US.

As proxy for risk aversion, see the euro/yen chart (daily basis). The EUR/JPY has yet to match-and-surpass the old low from end-May or the 50% retracement level. It’s well under the green 200-day mov-ing average, of course, but a bounce back to 137-141 would vindicate the idea that traders are willing to ring-fence the Greek problem and get on with their business-as-usual.

Ring-fencing is not new to FX trading. We recall something similar happening in the early 1980’s when it looked like Russia might invade Poland and a little later when the Red Brigade was trampling Europe. We had it when Clinton was being impeached and when the Supreme Count was choosing to override the Florida election to choose Bush Two. Ring-fencing specific problems is familiar and customary in FX. The equity gangs are more squirrelly, but FX traders are supremely pragmatic. They know constant hysteria results in bad trading outcomes, so let’s just ignore the source of hysteria and consider it one of the givens.

In fact, the euro can rise on Greek developments. Let’s pretend the eurogroup and ECB come to accept the IMF’s judgment that Greece needs some debt forgiveness (not the IMF’s debt, of course) plus €50 billion over the next three years. In a way, the IMF is agreeing with Greece that the current debt load is unsustainable, something anyone with a grain of sense acknowledged long ago. Debt relief and a new aid package would surely push the euro higher—while delays and squabbles and ill-will will get dis-missed as political business-as-usual.

This seems like a perverse outcome but it’s actually consistent with past behavior in the FX market. First we have to find out what the ECB is going to do, and the ECB is taking its lead from the politicians, chiefly Merkel. The sensible course of action is to leave ELA at the current level, although at some point the Greek bonds used as collateral could fail to meet even the ECB’s relaxed standards. The banks hold the key, or rather, the depositors hold the key. As long as some base of cash and credit remains in the banking system—and note that Tsipras has not uttered the magic word “drachma,” as far as we can find-- the banks or most of them might be able to squeeze by. Not without continuation or enlarge-ment of capital controls, though. At some point the already faltering Greek economy will literally run out of money as it gets stuffed under mattresses or smuggled abroad.

One tidbit that many readers thought useful and forwarded—French economist Piketty wrote a blistering op-ed in German newspaper Die Zeit, saying Germany is a hypocrite. “Germany is the country that has never repaid its debts. It has no standing to lecture other nations.” He says a study of history shows “Germany is the single best example of a country that, throughout its history, has never repaid its exter-nal debt. Neither after the First nor the Second World War. However, it has frequently made other na-tions pay up, such as after the Franco-Prussian War of 1870, when it demanded massive reparations from France and indeed received them. The French state suffered for decades under this debt. The histo-ry of public debt is full of irony. It rarely follows our ideas of order and justice.”

It’s a splendid article. The German economic miracle was based in part on not repaying debt, which the British took decades to do after the war with Napoleon. In fact, Piketty says, all of Europe needs debt restructuring. For fun, you can check out the NYT story over the weekend on Iceland’s recovery after default and bank failures.

What’s next? If our thesis about ring-fencing Greece is right, the euro can begin range-trading at a level higher than the lowest low so far, probably centered on that key level 1.1050.