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There is one thing on the markets' minds and one thing on global policy makers' minds at the moment: will Greece manage to stay in the Eurozone? With two days until Sunday's elections we have heard that the Bank of England will take action to try and cushion the economy from an implosion in the Eurozone, the Bank of Japan governor also came out this morning and said that Europe is the biggest risk to the Japanese economy and a strong yen could hurt exporters. It seems the only bank not willing to provide more support is the one bank that is considered part of the solution to this crisis, the ECB.
Draghi to markets: it's up to the politicians now...
The ECB President was addressing the ECB Watchers conference in Frankfurt this morning where he was very clear on a couple of things: 1, the Bank will continue to provide liquidity to the banking sector and 2, it is up to the governments of the currency bloc to sort this crisis out. Draghi also said that this complex situation cannot be sorted out with one action, suggesting that a sustainable solution to this crisis remains a long way off.
Is Grexit such a bad thing?
I had an interesting discussion with a driver this morning and he thought it was best for Greece to be cut loose so that it doesn't drown the rest of the currency bloc. He won't lose confidence in a currency bloc without Greece; in fact he would feel more secure in a currency bloc without Greece, especially due to its links to the UK economy. Thus, concerns that a Grexit would erode all confidence in the currency bloc could be an exaggeration. Markets may feel like this, but the man or woman on the street may not feel nearly as concerned.
Even if Greece does vote for an anti-austerity party and risks expulsion from the Eurozone there would be more financial resources and, crucially, political resources to deal with Spain, Italy etc. As I have said before, it is very much in Greece's favour to stay in the currency bloc, and not necessarily in the favour of the other members. Thus, the markets could be fairly sanguine in the run-up to the election, not because they think that New Democracy will win on Sunday (the race is wide open) and Athens will stay in the Eurozone, but they might be optimistic that an end to Greece's membership is also in sight. That would be devastating for the Greek people, but could help strengthen the currency bloc in the long-term.
Politicians have been short on long-term solutions to this crisis. Although Merkel has hinted at closer union, Draghi stressed this morning that this situation is so complex it can't be solved with one action. Thus, although the Greek election has been portrayed as a binary outcome: you vote for austerity and you stay in, you don't and you're out, the reality may not be as simple as that. Whoever wins on Sunday (the results are expected between 2100-2300BST) could try and re-negotiate the bailout terms to reduce the austerity measures, thus a win for a pro-bailout party may not eradicate the tail risk of Greece leaving the currency bloc one day and could keep markets nervous for some time.
Global central banks at the ready
While we expect excess market volatility on Sunday at the Tokyo open as the market reacts to the election result, in the long-term the downside could be limited due to the global central bank liquidity cushion, which could be deployed in the event of a negative election outcome in Athens. Markets love liquidity and if a party like Syrizia takes over power in Greece that could be a trigger for more QE from the Federal Reserve when it meets next week. So unlike at other stages of this crisis, global policy makers are at the ready. Added to that there is a G20 meeting next week and an EU summit at the end of the month, so there is the potential for long-term remedial action to be taken in the coming weeks. But the key question for markets is do we have weeks or is it mere hours before drastic remedial actions need to be taken?
Market moves: beware volatility
Spanish and Italian bond yields are down, stocks are being led higher by global banks and EURUSD is above 1.2630 - a key resistance zone and the Kijun line on the daily Ichimoku cloud. The pound is taking the brunt of the selling today after the BOE announced that it was cutting the cost for banks to borrow with it from 100bp above the base rate to just 25bps above the base rate. The pound is underperforming especially versus the euro and the Aussie today. EURGBP broke above 0.8120 - the base of the Ichimoku cloud, which suggests the bulls have the upper hand at the moment. The next resistance level of note is 0.8200. GBPAUD fell through 1.55 earlier, opening the way to1.5340 - a cluster of daily moving averages, which may act as near-term support.
But don't be fooled by the calm in the markets. When there is an event like a major election markets can buy the rumour and sell the fact. We have seen trading ranges narrow in recent days. For example the range in EURUSD on Monday was 200 pips, it fell to just 90 pips yesterday. When ranges narrow this can precede a volatile move, so be prepared for an explosive reaction to the Greek election result on Sunday night. A good result could see EURUSD trade towards 1.2750, while a bad result could see a sharp sell-off back towards the 1.2350 lows from the end of May. Watch out for large price gaps at the Tokyo open like we saw last week after the Spanish bank bailout, and be prepared for the markets to potentially gap both ways. Volatility means big price moves, so as long as you protect your capital with stop loss levels and watch your trades closely a fast-moving environment should not cause stress or fear.
Finally, we would not be surprised to see a mild sell-off this afternoon as investors square up positions rather than hold them through what may be a volatile weekend.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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