Fear over Greece May be Self-Fulfilling - Substantial Volatility Risk Ahead

• Greece fails to make meaningful process, showdown remains for next week’s key dates
• Government remains likely to run out of money without additional bailouts by mid-April
• Fear over failure to land a deal may be self-fulfilling; risk is sky-high

Greece remains a real risk to the stability of the Euro Zone and the Euro currency itself, the biggest risk to markets and the Euro may be uncertainty itself

Key Dates Set the Stage for Eventful Week Ahead

We recently wrote on why key dates in the week ahead could lead to substantial Euro volatility, and the central point remains very relevant: if Greece fails to secure additional bailout, it will run out of money and go into default—likely forcing it to exit the Euro Zone and causing great disorder across financial markets.

These key dates make this an especially pressing issue:

April 8 - Greek Government to auction €875 million in 178-Day Treasury Bills

April 9 - Greece is to pay €460m to the IMF under terms of first bailout agreement.

April 13 - €1,400m of short-term Greek Treasury Bills mature, forcing Greece to roll over into new debt.

April 16 - Another €1,000m of Greek Treasury Bills mature.

The fact that the Euro finishes the week near monthly highs suggests that few expect the April 8 debt auction will fail or that the Greek government will miss its €460m payment to the IMF on April 9. Yet the lack of progress in bailout negotiations between the Greek government and the European Working Group keeps market on edge.

The major risk is that fear of total breakdown may itself prove self-fulfilling.

Fear over Potential Greek Insolvency, Capital Controls Represent Massive Risk

If the Greek government fails to secure an extension of its bailout agreement, Greek banks will lose access to critical emergency lending from the European Central Bank and domestic investors may see little choice but to flee the financial sector. Government officials could proactively institute aggressive capital controls in an attempt to save major institutions from near-certain bankruptcy. And indeed this remains arguably the greatest risk—a full-scale bank run on fears of any such capital controls.

Large outflows from Greek banks have already pushed the financial sector to its limits, but fairly substantial Emergency Liquidity Assistance (ELA) from the European Central Bank has kept the broader system stable. Yet ECB officials have thus far not pledged meaningful increases in such assistance amid the lack of progress in bailout negotiations.

If negotiations get closer and closer to key deadlines without progress, the fear of capital controls may ultimately be self-fulfilling—particularly ahead of a Greek National Bank Holiday on April 10 and 13. As of now many have not resulted to such drastic actions, but if savers fear they will lose access to their cash they will almost certainly queue up at ATM’s and drain savings accounts ahead of the weekend.

Euro Reactions are Far from Predictable

Derivatives show 1-week Euro/US Dollar volatility prices remain high, but it’s worth noting that prices are considerably higher for 2-week options. In short, some of the most sophisticated traders in the world believe that the coming two weeks will bring substantially more uncertainty than the coming year.

Euro Volatility Prices Are Higher for 2-Week Options than for 1-Year—Clear Uncertainty Ahead

Data source: Bloomberg. Chart source: R, ggvis

Logically this makes little sense; there is far more you can’t know about what will happen in 52 weeks than in the coming two. Yet this shows the level of uncertainty heading into what threatens to be a critical period for Greece and the broader Euro Zone.

If we get closer to key deadlines without a clear solution, increased risks will likely make for illiquid FX market conditions as banks are unwilling to provide liquidity. In effect this means that the Euro could both rally and fall sharply on any news headlines.

Any surprises could force substantial market moves, and traders should limit trading leverage—particularly in EUR pairs—ahead of the key dates.