Fifty shades of Greece

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The relationship between the newly elected Syriza-led government and Greece’s official creditors has certainly not been black and white. However, I still think they will eschew the more extreme scenarios, as I argued in Greece Lightening and depict in Figure 1, and this will be one of a number of mildly supportive factors for EUR/USD.

Short honeymoon over but still negotiating room

Perhaps unsurprisingly the initial honeymoon between both parties has been extremely short lived and markets, including Greek yields, have since witnessed what I describe as “tidal politics” (see Figure 3). The tide goes out (negotiations make progress) then the tide comes in (negotiations stall or worsen), the question being where the waves ultimately stop and how much damaged is caused.

There were initial signs of hope:

  • Greek Finance Minister Varoufakis has shown some willingness to compromise. He appears to have watered down his ambition of a partial debt cancellation and confirmed that 60-70% of bailout-linked economic reforms demanded by creditors were acceptable. He has promised to tackle tax evasion and reduce oligarchs’ influence.
  • French President Hollande is seemingly supporting the idea of some debt restructuring (options B, C and D in the Figure 1).

However, that’s as far as the love has gone:

  • The ECB, one of Greece’s key creditors along with the IMF and eurozone governments, decided on 4 February to no longer allow Greece’s debt as collateral for ECB funding on the grounds that the government has abandoned the required austerity program. The Greek central bank now directly funds its banks via Emergency Liquidity Assistance (ELA) but the quantity of financing is capped at €59.5bn and with a higher interest rate of 1.55%. The ECB will review these arrangements around the 18th February and every two weeks thereafter (see key dates in Figure 4). Greek banks can buy Greek government issued T-bills to use as a collateral at the ECB but this is capped at €15bn.
  • Germany has given a cold shoulder to Varoufakis’ suggestion that current debt be replaced with GDP-linked-bonds and perpetuity bonds, with a bridging loan steadying Greece’s finances until June.
  • The Greek government is also sticking to its promise of re-hiring public workers, increasing wages and halting the privatisation program.
  • Creditors have blamed Greece’s fiscal profligacy for its current crisis while Greek officials have called for Germany to pay post world war two reparations.
  • Finance Minister Varoufakis and Djisselbloem, chairman of euro zone finance ministers, reportedly reached an in-principle agreement overnight, with Greece affirming its commitment to reform and repaying creditors, seemingly in exchange for some kind of bridge financing. But there has been no statement to this effect, with the Greek government reportedly vetoing the agreed-to terms and conditions.

A number of factors have compounded tensions or at least clouded the outcome, including i) the far-from-united view amongst eurozone governments, ii) outside pressure from the US for an agreement to be reached and iii) China and Russia potentially entering the fray with financial assistance. Conversely, private creditors have been surprisingly quiet so far.

A rainbow of possible outcomes and variations

I have listed in Figure 1 the potential outcomes of these negotiations, conscious of the almost limitless number of possible variations and shades of grey to these core scenarios.

olivier desbarres fig1 greece shades

Figure 1: Possible outcomes of Greece-creditor negotiations

Ultimately, I think this complex situation – which has seen emotions run high – boils down to who shares how much financial pain and credibility loss, and when.

For the creditors it’s a choice between:

  • More money now but potentially less money (or even no money if Greece defaults) in the future; and
  • Less money now through some form of debt restructuring (which other debtor nations may also seek) but potentially more money in the future if these countries’ solvency is supported by stronger growth.

For the Greek government, it’s a choice between:

  • Funding today and potential re-working of some of its debt but need to adhere to strict program conditionality and austerity and still heavy debt burden medium-term; and
  • No/less austerity today but likely even greater funding issues and economic pain further down the line.

Both parties would tell you it’s not much of a choice and unfortunately electoral cycles get in the way of sensible compromises, in my view. Specifically, the temptation for governments with limited time in power is to maximise their near-term upside (and ideally preserve their moral righteousness) and leave the bigger challenges to future governments.

fig 2

Figure 2: US retail sales rose only 0.6% in H2 2014

Figure 3: 10-year government yields well behaved …except in Greece

Figure 3: 10-year government yields well behaved …except in Greece











Scope for EUR/USD upside

Despite any clear-cut progress so far, EUR/USD has flat-lined for the past four sessions and I see scope for modest upside.

I still think that creditors and the Greek government will eschew the more extreme scenarios (A, B, H, I and J in Figure 1), as I argued in Greece Lightening. Greece has reasonably large debt servicing costs in March so the pressure to reach an agreement will intensify. The next fortnight presents both parties with formal forums to make progress (see Figure 4) but the market is growing thick-skinned to this kind of protracted negotiations between Greece and its creditors.

Further east, President Putin has agreed a ceasefire in Eastern Ukraine as of 15 February. How and for how long it is enforced is up for debate but he has at least showing willingness to sit at the negotiating table with the Ukrainian, German and French leaders. There are also some signs that the euro-funded EM carry trade may be losing some momentum. Finally, the US Treasury’s urging that Europe pursue fiscal spending at the recent G20 meeting may also have helped shore up the euro even if history tells us that it will do little to markedly change G20 countries’ fiscal and exchange rate policies.

Today’s US retail sales data for January (out 13.30 London time) are an important litmus test for the US economy, currency and monetary policy in my view. Despite the fall in energy prices and robust employment, retail sales have struggled to lift-off rising only 0.6% in H2 2014 (see Figure 2). Consensus forecast is for headline retail sales to have contracted 0.5% mom in January.

Figure 4:  Key dates

Figure 4: Key dates


Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He is a former G10 and emerging markets economist, rates and currency strategist with over 15 years’ experience with two of the world’s largest investment banks.


Fig 1 –

Fig 2 – US Census Bureau

Fig 3 –

Fig 4 –

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