“We have been above consensus with our EURUSD forecasts this year, but now put them under review for a significant downward revision,” says Chris Turner, head of FX strategy at ING Financial Markets. “A retest of the year’s low at $1.3140 seems likely, while a break down to $1.20 cannot be ruled out.”
Analysts say the Greek referendum crystallizes the implementation risks that impede the path towards a solution to the eurozone sovereign debt crisis, and will push investors towards the relative safety of the dollar.
Late on Monday, Greek prime minister George Papandreou announced he would hold a referendum for the approval of the most recent rescue deal for Athens from the troika of its eurozone partners, the International Monetary Fund and the European Central Bank, if his party received a parliamentary vote of confidence on Friday.
The news brought about a sharp decline in risk appetite on Tuesday. In FX markets, EURUSD reversed the majority of its recent gains, falling below $1.3650 around midday, London time.
Other asset classes also suffered from the reversal of sentiment, with the spread of the yields of Spanish and Italian government bonds widening over their German counterparts, and European bank stocks tumbling.
Ultimately, uncertainty has returned to the eurozone, but the result of any referendum remains unclear.
Indeed, polls indicate around 60% of the Greek public opposes the recent bailout agreement, yet 70% want to stay in the eurozone.
Some have viewed this as a political move from Greece, to shift the balance of power from European leaders to the Greek electorate in response to fears that the demands of austerity measures made on the county would become excessive.
Economists at Citi see the event of a referendum as an implicit vote for Greece to decide whether or not to remain in the eurozone.
Should Greece decline the conditions of the second Greek bailout package, there would be no support from the Troika. In that case, Greece is likely to run out of funding quickly and would probably move into a disorderly default procedure. Funding from the ECB would also soon dry up as Greek banks run out of collateral and, as a consequence, Greece would probably be forced to exit the monetary union.
“The other alternative in the event of a rejection to the bailout package would seemingly be for European leaders to revise the terms agreed at the EU summit, yet the scope to do so is limited,” says Adrian Schmidt, FX strategist at Lloyds Bank Corporate Markets. “It’s very hard to see what policymakers can do if the decision is now put in the hands of the Greek electorate.”
In the meantime, it is clear the political risks in Greece will be the key driver for potential weakness in the euro, with further euro downside now likely as the market awaits clarity.
With the number of attractive safe havens now limited, given the seemingly rock-solid EURCHF exchange-rate floor and the recent record intervention by the Bank of Japan, investors are likely to return to the safety of the dollar.
“The dollar is the likeliest safe haven to absorb outflows of Europe and we see positioning for further EURUSD downside as the safest trade in the current environment,” says Valentin Marinov, FX strategist at Citi.
Risk-correlated currencies, with financial and economic exposure to the eurozone, are also likely to be victims of the deteriorating outlook, according to Marinov. These would include Scandinavian crosses, and also sterling – EURGBP, trading at £0.8560, is below Citi’s fair-value estimate for EURGBP at £0.8720.
Analysts at Barclays said the uncertainty surrounding the Greek political situation, in addition to the negative economic fundamentals in the euro area, will result in a prolonged drag on risky asset markets and the euro until some degree of clarity returns.
“The news means we are likely to see the risk premium on euro continue to rise again,” says Barclays Capital in a report to clients.
For those with a constructive view about risky assets in the near term, Barclays’ strategists recommended selling the euro against G10 commodity currencies with strong fundamentals, such as the Australian and Canadian dollars.
“But given the news, consider it wise to stay close to the safe havens, preferring to express our concern by remaining short EURUSD,” the report concludes.