- Currency markets are currently very complacent
- A Greek YES-vote will result in only a temporary recovery of the euro due to a refocus on cyclical factors…
- …while a NO-vote could trigger market volatility and a lower euro
Relative calmness in the market
On Monday morning the euro fell sharply in thin market conditions, because of the increased risk of a Greek default and euro exit. Surprisingly, it staged a sharp recovery afterwards. This reflects that the market was already positioned for euro weakness so some investors used the lower euro to close short positions. In addition, there is confidence that if a Greek exit were to occur, the contagion risk would be limited. This is because exposures to Greece have declined over the last few years. Furthermore, the ECB’s QE and OMT programmes are available to limit volatility and stress in financial markets. Moreover, the Swiss National Bank intervened in currency markets to weaken the Swiss franc which indirectly supported the euro. Later during the week, the euro fell under pressure again versus the US dollar as some improvement in investor sentiment resulted in a refocus on fundamentals and cyclical factors again. US economic data came in stronger-than-expected and this supported the US dollar across the board. In addition, investors have adopted a wait-and-see approach as they await the Greek referendum outcome on 5 July. In the remainder of this report we focus on the impact of a YES or NO vote in the Greek referendum. Our base scenario is that there will be a Yes-vote that will open the door for a new deal between Greece and its creditors.
A YES-vote will result in a refocus on cyclical factors
A YES-vote will result in an improvement in overall investor sentiment and a refocus on economic fundamentals and monetary policy divergence. We expect safe-haven currencies such as the yen and the Swiss franc to weaken. The euro may post a recovery but we expect this to be temporary as the market will refocus on monetary policy divergence again. This week US economic data have surprised market consensus positively, especially US employment report was strong. As a result, a September rate hike by the US Federal Reserve will be increasingly likely (our call). This outlook should support the US dollar across the board even as the Greek debt crisis eases. This is because the US dollar is currently driven by cyclical forces such as the relative economic performance and the outlook on the Fed.
A NO-vote could trigger significant market moves
If the result of the Greek referendum is a NO-vote, this could trigger market volatility. This is because the risk for a Grexit would rise sharply. The results of exit polls will likely come in before financial markets open on Monday. We expect a risk-off scenario with safe haven currencies benefiting. It is likely that the euro will fall under pressure across the board. EUR/USD could test the previous low in EUR/USD on 13 March just below 1.05 in the days that follow. The Japanese yen and the Swiss franc will rally strongly in our view, because of their safe-haven characteristics. A stronger Swiss franc is likely to trigger FX intervention by the Swiss National Bank again. A yen rally to 120 against the US dollar cannot be ruled out. This is likely to trigger verbal intervention from the Bank of Japan. On the other hand, growth-sensitive and commodity currencies will weaken in our view.