Why Grexit Not Likely But Euro Stay Doomed

Syriza's win added pressure to the Euro as it signified Grexit risks increase that will disturb economy recovery in the Euro area.

Syriza triumph in Greece Election on Sunday added to the pressures suffered by the Euro due to the worries that it may trigger Grexit that will disturb economy recovery in the Euro area. Ahead of the first Fed FOMC in 2015, many speculations arise around whether another Greek tragedy is on the horizon. To put it crudely, the main concern is if the elected government will be so stubborn as to infuriate Euro with their demands, thus caused them to get thrown out of the Euro membership.

Greek Debt Pit

As is known, several years ago Greece bankrupted and triggered European debt crisis. In order to get out of the financial disaster, Greece begged help from The EU and IMF in 2010. But it was not enough. Around a year later, they proposed second bail-out that was agreed by the tripartite commitee Troika: European Commission (EC), ECB, and IMF. The bail-outs are not free as Troika conditioned Greece to follow an especially strict Austerity programme. It was bad news as far as Greeks go; austerity measures are blamed for extreme wage cuts, the closure of more than a hundred thousand businesses, 25% unemployment nationwide, and so on. Consequently, the Greeks have repeatedly taken to protest the measures on the streets.

The Alexis Tsipras-led Syriza party is one of the two parties that publicly oppose bailout terms and conditions. Their mission to challenge the Troika gained traction among the masses and so they are able to catapult into clear victory in the recent election. However, Tsipras's campaign pledge to shut austerity measure as soon as they step into power has angered Germany. As lead country in the Eurozone and one country that bear the most burden from bailing out Greece, German along with other leading officials of the Eurozone have signalled that the previous agreements should be adhered by the newly elected government. Thus give raise to speculation of a Grexit where Greece either will exit the Eurozone or 'being asked' to do so. If Grexit really happen, it certainly will inflict massive waves in the financial market and might even risk contagion to other Euro periphery countries.

Five Reasons Why Grexit Not Likely Happen

Although admittedly there are discords, Grexit is not likely to happen. It is because of the following five reasons:

1. Greeks Want To Stay In The Euro

Alexis Tsipras might have pledged to renegotiate Greek international debt agreement, but polls have shown that although Greeks dislike the said agreement, 75% voters still want to stay in the Euro. Therefore, the key is in the renegotiation between Tsipras and the Troika, especially how the two will compromise on key issues.

It needs to be noted that since shifted from Drachma to Euro, Greeks have tasted vast economic growth and many other benefits as a part of the privilege. Although they are angry with bail-out terms, it does not necessarily mean that they hate the single currency concept.

2. Euro Officials Are Ready To Cooperate As Long As Bail-out Terms Adhered

Eurogroup head of euro zone finance ministers, Jeroen Dijsselbloem, said to CNBC yesterday (26/1) about Syriza victory, They have made a clear victory and that deserves congratulation, and of course I wish them a lot of success in their new job in Athens. We stand ready to work with them, as we have worked with the previous Greek government. Dijsselbloem consider the previous government have done much in reducing Greek debt burdens, and said about the new government, We have always said that we will continue to work with them—if the Greeks commit to what we have agreed.

3. Euro Now Is Better Than Euro In 2012

Other debt-laden countries in the Eurozone periphery, most notably Portugal, Ireland, and Spain, are now in relatively better state than during the peak of Euro debt crisis. Banking rescue packages stand ready in various countries, and ECB have promised to continue channelling liquidities as its QE program was announced last week. In short, contagion risk is fundamentally smaller and more manageable.

4. Huge Greek Debt

Greece now owes 350 billion USD to the Troika and other smaller creditors. From that amount, 3.5 billion Euro bonds will have to be paid on next July, and the next 3 billion on August. The country will not be able to pay them off without the next part of bail-out funds. Greece will also not able to borrow from any other entities if they purposefully neglecting the previous debts. In the circumstances, there are pressures on the Greece to continue accepting Euro funds. What's more, after promising a number of sweets during campaigns, Alexis Tsipras could not possibly let Greece to plunge into the bottomless debt pit again. Therefore, he has to quickly renegotiate with the Troika in order to reach new agreement.

5. There Are Spaces For Compromise

The weight of Greek debt and the lessening Eurozone burdens have led many analysts to the conclusion that Greece probably will stay in the Eurozone and abide by the Troika wishes up to some point. Furthermore, there are still spaces for compromise if Tsipras and the Troika decide to renegotiate. Some of the probable terms include rescheduling of debt payments, interest cut, and looser fiscal targets. In returns, Greece will probably asked to establish several structural reforms, such as corruption alleviation.

Doomed Euro

If Grexit happen, then Euro-denominated assets are doomed. But actually, although Grexit failed to take place, analysts stay bearish on the Euro. This is because:

1. Investors will stay apprehensive as long as there is no new agreement between Greece newly elected government and the Troika.
2. ECB QE last week was announced as expansion of the current ABS buying program; from March 2015 until September 2016, the ECB bond buying program will be expanded to 60 million Euro per month and included ABS, covered bonds, and sovereign bonds. It sounds like a half-hearted attempt on the ECB part; but nevertheless, the program came while US The Fed is considering tighter monetary measures.
3. The QE will only be started in March and is not expected to instantly lift Eurozne economy.

In the circumstances, EUR/USD currently is expected to get involved in a big movement. David Rodriguez from DailyFX yesterday (26/1) wrote that the pair volatility indicate prices will probably move around 250 points this week. He warned that price momentum and tight positionings mean there are risk of reversals.

While BK Asset Management Managing Director, Kathy Lien, in her newsletter remains suggested to keep selling the Euro. If Fed statements in the next FOMC stay unchanged, the US Dollar will strengthen and EURUSD will go even lower. Although EURUSD has broken through 1.1098, she consider QE may inflict further losses for a currency. According to Lien, If 1.1200 is breached again, we could see the EUR/USD hit and most likely break 1.10. In other words, pullback in the EUR/USD pair could be used to sell from higher level.

On the other hand, Danske Bank predicted there will be no big news in the next Fed FOMC. They will focus on what officials say after the meeting, but maintain first rate hike timing estimation on 0.25 bps in June.