John
Kicklighter
PROFILE: John Kicklighter is the senior currency strategist for FXCM in New York where he specializes in combining fundamental and technical analysis with money management. John authors a number of regular articles for DailyFX.com View profile at FXstreet.com
What will happen with Greece? Which will be the ripple effect consequences? These are some of the questions that everyone has in mind lately. We have asked John Kicklighter, senior currency strategist for FXCM in New York, for some answers to bring some light to this complex issue.
One year ago we heard for the very first time about rumors of Greece leaving the Eurozone. What has changed in one year to go from considering it just gossip to taking it as a real fact?
The facts behind the scenario haven’t changed drastically. Instead, we have progressed through the steps that the situation was expected to take given its serious fundamental headwinds. In the past year, we have seen the second bailout program drowned in contingencies, a debt restructuring without technical default, inconclusive elections, and market-wide liquidity programs (LTRO injections) among other developments. Arguably, each policy change that is made should be aiming towards strengthening Greece’s financial position and perceived stability, but the market doesn’t interpret the effort as being supportive much less effective. The situation is deteriorating more from the market’s assessment rather than material progress; yet when confidence is the prerequisite for raising capital in the bond market or Greek citizens withdrawing money from the banking system, gossip and speculation become the driving force.
Which are the most exposed countries to a Greek Eurozone exit, the rest of the PIIGS or the lenders like Germany and France? Would Greece's departure from the single currency create a ripple effect and fuel the exit of other countries in the short term?
'A Greece exit for the Euro Zone would act as a benchmark for those with similar ambitions'
A Greek exit would be costly for all Euro Zone members. Between the two tiers (core and periphery), the situation would be slightly different. Countries like Germany and France have foot a larger portion of the bill, and therefore would take the biggest notional hit in the event that Greece were to withdrawal. That said, they are in a better position to withstand the impact as their economies are comparatively strong and liquid. The direct lending lines for periphery and fellow-bailout members (Portugal, Ireland, Spain, etc) are relatively small, but the implications are far greater. An exit for the Euro Zone would signal to the market that their Euro Zone investments are highly uncertain and thereby hurt the most fundamentally unstable. Further, it would act as a benchmark for those with similar ambitions. If Ireland or Portugal wanted to recover their ability to set monetary policy, they can use Greece’s success or trouble in the endeavor as their guide. It should also be said that the first to go will make it make further exits more efficient.According to recent reports, a Greek Eurozone exit would not only threaten other European countries with contagion, but also hurt exporters and commodity producers such as China or Russia. Which non-European countries would feel the greatest damage in your opinion?
Should Greece leave the Euro Zone, there are a number of countries that have invested in the region that will see their exposure delivery significant losses. Trade deals and cross-border investments made on the explicit basis of some implicit ‘Euro Zone’ guarantee will lose their inherent assurance. That will harm the entire region and subsequent translate into a drop in consumption for the largest collective economy in the world. We are already seeing the negative implications a mild recession for the Euro Zone can have on its trade partners – though it is difficult how much to actually attribute to the imbalance. From a trade standpoint, China, broader Asia and the emerging market countries in general would all suffer. From a financial standpoint, the backlash of a second wave global financial crisis those that have built their strength on the rebound in capital markets will be hardest hit.
How well is the US prepared for such a possibility? And the rest of the world?
'We don’t know how the situation progress in Europe and how it could potential transmit abroad. If the contagion is through credit and funding markets, the US will definitely feel the impact'
Since the 2008 financial crisis, US banks and policymakers have taken steps to strengthen their funding position and reduce leverage. There are still serious holes in the effort of course (as JPMorgan’s recent loss shows us), but the effort is notable. From the consumer’s stand point, the country has worked down its debt load tremendously over the past three years. Alternatively, the government and central bank have raised their exposure in an effort to help the consumer and investor. All told, the US is aware of the problem and already following a policy that would bolster stability in the face of crisis. That said, it is impossible to fully isolate the United States from the backlash of a crisis that emanates from the Euro Zone. As the largest economy and market in the world, the US will be exposed to global ills. What makes the situation particularly difficult to prepare for though is the issue that we don’t know how the situation progress in Europe and how it could potential transmit abroad. If the contagion is through credit and funding markets, the US will definitely feel the impact.The US is already focused on 2012 presidential election. Could an European failure impact on the election race?
If Europe is unable to stem its crisis, then the spread of both financial trouble and economic slowdown will no doubt hit the US. Finding a country mired in such a mix draws a much higher probability of party change – as we have certainly seen in numerous European countries recently and arguably in the United States back in 2008. The influence that the ‘wealth’ effect carries in election periods can be quite substantial, if not a leading consideration in poll. That being said, a deterioration in the situation for Europe does not necessarily assure a crisis for the US. If regulation and policy can manage the impact of foreign contagion, it could actually prove a rally point for President Obama and his fellow Democrats.
In a technical approach, how will react the EUR/USD? Has the market already discounted this scenario?
At this point, the market is aware of the disaster scenarios that exist for the euro should Greece exit the Euro Zone. That said, we have not fully priced in any one outlook. One key consideration is that for a scenario to be fully priced in, everyone would have to be on board. Otherwise, there will always be a contingent that is taking exposure for some other outcome and would therefore have to change their position should the alternative view not come to fruition. Further complicating the matter, there is heavy disagreement over what the further fallout would be beyond the moment Greece exits. Will others follow Greece in bowing out? Will guarantees suffer for the small net GDP of the Euro Zone or improve because of the improved debt-to-GDP ratio? Will Greece continue to be a burden even after it leaves? The answers to these questions are still murky as there is no clear answer.
With a decaying Eurozone, will the SNB be able to maintain the 1.200 floor for the EUR/CHF or will change its policy?
'The SNB will not likely be able to keep the 1.2000 floor in place if the Euro Zone situation continues to fall apart'
The SNB will not likely be able to keep the 1.2000 floor in place if the Euro Zone situation continues to fall apart. To this point, the central bank has vowed only to buy unlimited amounts of euros to keep the EURCHF level - not to boost it to further heights. As we hover around this threshold, we risk that an escalated crisis for the regional economy and markets will leverage panic and send investors rushing to safe havens (like the Swiss banking system). Raising the floor would be a temporary solution, but introducing capital curbs goes to the heart of the matter – discouraging foreigners from seeking asylum in the renowned harbor to financial storms.
