What Does a Greek Default Mean for the Currency Market?

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 |  Includes: ERO, GRDOW
by: Andrei Tratseuski
With a pending vote regarding Greece around the corner, the market is becoming optimistic about a positive outcome. The vote, which is due Tuesday at 21:00GMT or 4:00PM EST, is important for further guidance of EUR/USD. On the table is potential default of Greece, a contagion effect and the overall well-being of the Euro-zone. With the following premise in mind, let’s analyze what is on the line and how it may affect the currency market.
1) Confidence vote from Greece –Tuesday at 21:00GMT will be crucial for the market. The Greek Parliament will rule on austerity measures proposed by EU/IMF venture. Austerity measures include: huge government spending cuts, increase in taxes and privatization of government assets.
2) If austerity is not passed, Greece might not get the rest of bailout at the full amount of €12 Billion. Without the money, Greece will not have enough funds to meet next month’s obligations, prompting a default. If this happens, Greece will not be able to borrow from ECB and a potential run on the bank can result, drying liquidity and credit markets. Obviously a EUR negative.
3) Currently Greece owns €340 Billion in debt, or roughly 140% of GDP. That is roughly €30k per every person in the country. The debt is expected to continue to swell for the time being. Furthermore, Greece has the lowest sovereign debt rating out of all nations in the world. Any hints of further default could swell borrowing cost of Greece and put it in bigger hole. The current borrowing yield on 10-year note is above 17% per year.
4) The contagion affect is a big possibility. Without a bailout, a potential default of Greece could structure a contagion effect. Markets will be likely to punish Portugal, Ireland, Spain, and Italy if Greece defaults; this will be a negative development for Euro. Furthermore, about 70% of Greek debt is outstanding abroad. With heavy exposure by French and German banks, any default would cause abundant losses and might require a government bailout of the specified banks-- a situation that closely resembles Lehman Brothers.
5) The amount of a second bailout for Greece – Markets are currently expecting additional €120 Billion for a second bailout of Greece. Only actions of Greek Parliament can secure additional loans.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.