June 12

Greek Default Could Spark Massive Euro Rally

The last week has seen EURUSD fail to make further declines after three straight very impressive US data points. Non farm payrolls, retail sales and consumer confidence have all beat expectations by a wide margin. Traders continue to scratch their heads as illiquid markets whipsaw back and forth in relatively tight ranges.  What we do know is that liquidity is very low and the consensus is that Federal Reserve rate hikes are coming in September. In my post earlier this week I talked about the connection between the S&P 500 and the Dollar, mainly focusing on USDJPY. Kuroda’s comments on the Yen sent USDJPY tumbling, I took profit on that trade and am now looking at the Euro for further examination.

I honestly cannot think of any logical reason why a Greek default would send the Euro significantly lower. Most of the losses would be taken by the IMF, ECB and the various Eurozone federal governments. If anything there would be a huge blow to confidence in not only the economic recovery but the viability of the Euro itself. One thing we do know is Germany is never leaving the Euro, so each country that leaves only takes us closer to a German currency that in all likelihood would be even stronger than the Pound relative to the USD. A Greek default could cause outflows in Eurozone bond and equity markets, but most of these positions if held by foreigners are currency hedged.

On the Dollar side, any massive blow to global confidence combined with a selloff in equities removes the consensus case for a rate hike within the next 90 days. This creates a “double consensus” of big Euro short positioning due to ECB QE, and expected Fed rate hikes. We have seen again and again in the last three years how dangerous consensus positioning can be, and it will only be more risky in this new world of ultra illiquid bond and currency markets. There are probably an huge amount of stops above 1.1500, a quick run thru that level could set off the greatest stop run we’ve ever seen.