On Sunday, Greek PM Alexis Tsipras put his political future and, more importantly, the future of the common currency in the hands of Greek voters. It was the political equivalent of pushing one’s chips all in at the poker table and after Sunday’s referendum, Tsipras appears to have been holding a better hand than Junker, Dijsselbloem, and Merkel.
With his grip on power in Greece now virtually unassailable (at least in the short-term), the PM will need to switch gears quickly. Having won the political battle, they must now fight the economic war, and while Sunday’s plebiscite may have given the world some clarity in terms of what the Greek government’s mandate truly is, we are no closer to solving the stalemate which has brought the Greek banking sector to its knees and threatens to plunge the country even deeper into depression.
In fact, Sunday’s vote represents a kind of worst case scenario for financial markets. The fact that Greeks’ resounding repudiation of austerity may well have been influenced by the IMF’s tacit admission that the country should indeed hold out for debt relief from EU creditors sets a dangerous precedent for Europe. Christine Lagarde effectively forced Brussels and Berlin to blink on the eve of the referendum and you can bet that Podemos in Spain, the Socialists in Portugal, and the Five Star movement in Italy are watching closely to see what happens next.
If Greece proves that the will of the people and the threat of a voter-supported EMU exit is sufficient to secure debt writedowns, the experiment that is the currency bloc will begin to crack as soon as this fall when elections are expected in Spain and Portugal. This threat alone will likely be enough to push spreads on periphery bonds wider in the short-term and may well introduce quite a bit of unwanted volatility in EU equities as well.
But that only captures half of the story.
In addition to the negative impact on capital markets from the political turmoil that Sunday’s vote may well spark, the market will now have to cope with the economic fallout as well. The Greek banking sector is teetering on the edge of outright collapse, as is the Greek economy where consumers will soon face a shortage of imported goods as credit dries up and ATMs go dark. Any spillover from this — and make no mistake, there will be some spillover — will exert still more pressure on financial markets as negotiations between Athens and Brussels drag into their sixth month.
Through it all we’re told that Mario Draghi will save the day and that the ECB has the “tools” in place to combat contagion. Here with a rundown of those tools and a look at when and how quickly they can be deployed, is Soc Gen.
Tools to stem contagion
- Accelerating QE. QE is not designed to assist individual countries, but with a monthly firepower of €60bn, it remains a powerful force. Moreover, contrary to the OMT that requires agreement on an ESM programme to be activated for a specific member state, the QE tool is already fully active. Should contagion from Greece become more substantial, the ECB could front-load QE without further notice. The ECB could also seek to step-up QE from its €60bn pace, officially to fight an unwarranted tightening of monetary conditions but within the 25% issue limit and 33% issuer limit. We are doubtful, however, that the national central banks (NCBs), where the bulk of the risk of the QE programme is assumed, would buy anything other than their own national debt. Moreover, were the ECB to substantially increase QE it may be open to criticism of monetary financing at a time when the German Constitutional Court is still reviewing the OMT. If contagion is limited to a few member states, arguing on the grounds of deflation risks for the broader euro area – the justification for QE – may also be more complex.
- ESM and MoU for countries facing tension. Different facilities exist in the ESM: loan, credit lines, bank recapitalisation and primary or secondary market purchase. The latter is likely to be the most efficient and easiest option. The ESM may buy bonds either in the primary or secondary market of any Member States that requested it. The primary market facility is only opened to countries under a programme (i.e. only Cyprus as of now) while the secondary market is also available for non-programme countries whose economic and financial situation is sound. However, in that case a Memorandum of Understanding (MoU) detailing the conditions attached to the facility would need to be approved.
- OMT. The tool to deal with the risk pertaining to individual sovereigns is the still untested OMT (purchases of bills and bonds having a maturity lower than three years). The OMT programme requires the backing of an ESM programme as well as a clean bill of health on debt sustainability. If that is not the case, step one in the prescribed process as set out in the ESM Treaty is restructuring.
The implication here certainly seems to be that the preferred contagion containment tool is the acceleration of QE ("more cowbell" so to speak).
This will come as no surprise to the Zero Hedge faithful. Less than two weeks ago in “Goldman’s Conspiracy Theory Stunner", we remarked that the bank (and Mario Draghi's former employer) seemed to be suggesting that the ECB would actually be just fine with Grexit, because it would give the central bank an opportunity to expand QE. Sure enough, just a little over a week later, the ECB effectively primed the pump by expanding the list of PSPP-eligible SSA bonds.
So get ready, because just as we predicted before we knew what the results of Sunday's referendum would be, "€60 billion/month is about to become €70 or €80 billion and then, once the EGB and SSA markets have been sufficiently cornered, it will be on to euro IG corporate credit before Draghi finally becomes Kuroda by throwing the ECB's balance sheet at the DAX, CAC, and IBEX at the first sign of trouble."
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