Over 3 billion euros will flow from the European Central Bank to Greece, and they'll make it back safely back. This Greek vacation for the ECB's money will prevent a Greek default in August, and will allow the leaders more time to find another temporary solution in September.
The reasoning and the mechanism are only a bit more complicated than the simplistic description above. Here's how the revolving doors work.
Greece has a bond payment of 3.2 billion euros to the ECB due on August 20th. As Greece doesn't have the money, there were expectations that Greece would pay with the next tranche of aid it would get from the EU / ECB / IMF troika.
However, the troika delegation found that Greece missed too many of its targets according to the second bailout. After discussing more cuts, the troika left Greece and announced progress, but no details about the next payment, nor steps that Greece would be requested to undertake.
The delegation is expected to return only in September (they probably cannot work during August).
However, the clock is ticking, and an interesting solution was found: Greece will raise money on the markets, selling 3.125 billion euros of three month T-bills on Tuesday, August 15th.
Everybody knows that Greece is shut out of money markets. Otherwise, it wouldn't have needed a bailout. So, Greek banks will help by buying most of these bills. However, also Greek banks are struggling, especially after the deep haircut they were forced to volunteer for back in March.
So, the ECB will lend the money to Greek banks using the Emergency Liquidity Assistance (ELA) program. This has become easier after the ECB raised the limit of Greek T-bills it would accept in order to give these emergency loans.
So, money passes from the ECB to Greek banks, to the Greek government and back to the ECB.
In the meantime, it's clear to see that the second bailout isn't having great success, to say the least. The head of the eurogroup expressed peculiar optimism, by saying that he doesn't see Greece leaving the eurozone at least until the autumn and probably not afterwards.
The autumn is very close, and this may be the last transfer of money that Greece receives from Europe.
Everybody is talking about the Grexit, yet when it eventually happens, there will still be a shock. This is uncharted territory - a member never left the eurozone. A lot of uncertainty will be left about:
- Actual devaluation of the drachma against the euro - ballpark estimations are 50-70% but nobody knows. This has a strong impact on the actual costs of the Grexit.
- State of French and German banks after this move. They are the most exposed entities to Greek debt, yet some have already begun writing off this debt.
- Actions of the ECB and politicians as a reaction to this move, and if these actions will be sufficient.
- Contagion effect: The "domino effect" is the biggest fear. While Greece owes a lot of money to other European countries, its economy is only 2.2% of the eurozone's economy. Italy and Spain are much bigger. Spain and its banks are already struggling and the credit crunch is felt in some areas of the economy.
So, a huge Sunday gap is likely. Yet as always, markets tend to overreact and make extreme moves and tend to correct. Once the picture becomes more clear, markets will stabilize.
Two Ways to Trade It
The Grexit can trigger huge moves, similar to the ones seen after the collapse of Lehman Brothers. This provides an opportunity, but also poses risk.
- Bet on the exit: I am using the word "bet" as this event isn't 100% and the timing is very hard to guess. This tactic means going short on the euro on Friday. Then, as markets open and the euro falls, cover the position rather fast. As violent corrections can happen. Even if the gap isn't closed (most likely, and will serve as a bearish sign) it will be hard to tell how the currency will move in the wake of the European session, when liquidity rises and the picture regarding the Grexit becomes clearer.
- Trade the Exit: This is a "safer" tactic, but yet again, a Grexit is uncharted territory. The best way is to go with the trend, going short very early. The gap will already be behind us, but some falls are certainly possible. Another, less recommended tactic is to try and pick the bottom and go long - catching the violent correction. This will likely be short lived.
What do you think? Is this a tradeable event? Will you consider trading it?Disclosure:
I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.