Citi’s Steven Englander put out an interesting note yesterday titled: If the Greek bailout is so bad, why is the EUR so strong?
The argument goes like this: Everyone and their cousin believes that the Greek bailout is a joke that doesn’t stand a snowball’s chance in hell of really working. A lot of people thing Greece will leave the Euro this year. And then that opens Pandora’s Box for more trouble in Portugal, and everywhere else. And yet! Peripheral yields are calm, and the Euro is robust.
There’s a disconnect between what everyone is saying about Europe and what’s happening in markets, which is calm.
And actually, he doesn’t have much of an answer.
He does point to this chart, showing the general collapse in volatility around the world — basically Euro volatility vs. the VIX — as being indicative of ongoing calm everywhere.
Coming back to the question of why the euro is surprising to the upside, we would therefore point to indications that markets are calmer about risk, despite the bailout’s imperfections. The VIX and EUR (as well as other currency vols in general) have moved down since the agreement. Again the question is not whether the Greek economic and debt glide path is viable, but whether it will hang together for long enough for asset markets to become immune to the consequences of slippage. One can debate whether the package will far apart within three months and what the consequences will be, but that is much different than saying the EUR should sell off today because Greek debt will not be at 120% of GDP in 2020.
Similarly there is a lot of discussion about G20 and whether the IMF and European finance ministers will come to an agreement on their relative contribution, but G20 is the last institution that is likely to provoke stress in global financial markets. Whether they agree or agree to delay, the odds are slim that the trigger for an extended EUR sell-off will be this group. And finally, if you read the Draghi WSJ interview a lot of what is quoted as pessimism is actually him making sure that all doors are left open for further policy measures.
Net, net what continues to strike me is how low baseline expectations are for the EUR and how all it takes is a bit of easing of tail risk to push it upwards.
By the way: If you haven’t seen it, here’s the tear the euro has been on over the last several sessions.
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