After Initial Drama, Calmer Markets, Even If Nervous, Prevail

The global capital markets responded in a typical risk-off fashion to the sharp victory in Greece for the rejection of the creditors’ demands. However, by the time European markets opened, some semblance of stability was emerging. European equities gapped lower, but quickly began recovering. Core bond yield fell and peripheral bonds weakened, but in a fairly contained fashion.  

In the foreign exchange market, the key axis is euro-yen. The euro was sold and the yen bought on the initially news. The cross briefly traded marginally through last week’s lows, but also recovered to closed the opening gap. Against the dollar, the euro approached last week’s spike low near $1.0950. It recovered toward $1.1100 before running out of steam.  

The resignation of Greek Finance Minister Varoufakis was seen as a goodwill gesture, but the issue is bigger than personalities. Recall that Greece was cut off of aid six months before Tsipras and Varoufakis took office. Varoufakis had already been pulled back from the negotiations, and still an agreement proved elusive. We see many observers claiming that the referendum results makes a Greek exit the most likely scenario. We think that once again, investors may be reducing monetary union to a set of economic relationships, and failing to appreciate the political will.  

What are the immediate next steps? Three meetings are key. First, Merkel and Hollande will confer. It does appear that the “no” vote exposes some differences among the creditors. Led by the German Finance Minister, there is a wing of the German political elite that seems willing to take the “no” vote as a desire to leave union, as many EU leaders had warned. However, this does not appear to be Merkel’s view. Hollande and Renzi seem to want to resume negotiations as soon as possible and maintain the integrity of the monetary union.  

Second, the ECB will meet to discuss the Emergency Liquidity Assistance (ELA) and the collateral. The only reasonable decision at this juncture is to maintain the current ELA cap and not change the collateral haircuts. Maintaining the status quo, to be sure, is not neutral. The banks are reportedly running notes. Without new ELA funds, there is risk of further banking problems–ATMs running out of cash with fewer operating.