Many US traders are waking up this morning expecting the euro to be trading much lower but instead of dropping to 1.08, EUR/USD recaptured 1.10 and is hovering slightly above 1.11. While some investors may be relieved that the Eurozone could rid itself of Greece, the recovery in the currency does not reflect this sentiment. Instead some investors are still hopeful that a deal is possible especially on the back of supportive comments from Eurozone officials. We’ve heard from many European policymakers this morning and they are either trying to downplay the impact of the Greek crisis or saying that a deal is still possible including EU’s Oettinger, French Finance Minister Sapin, President Hollande and Spain’s De Guindos. We haven’t heard much from Merkel but we expect to very soon. There is still a small chance that a deal could happen but with less than 24 hours to go before the June 30th deadline, mountains need to be moved for an agreement to be made. However even if Greece misses the IMF payment tomorrow, IMF Managing Director Christine Lagarde won’t officially classify Greece as defaulted for a few more weeks. At minimum, they will wait for the referendum to see if the Greek people will accept the deal.

The euro is also being supported by intervention from the Swiss National Bank who is buying EUR/CHF to actively weaken the Swiss Franc. Many investors also unwound their long euro positions going into the weekend and on Sunday evening but once the initial move faded, the unwind of short euro carry trades filled the gap in the currency. When the FX market opened on Sunday, the single currency dropped from 1.1150 to 1.0955 after Greek Prime Minister Tsipras called a referendum on the new bailout deal on Friday evening. At the time, many investors dumped euros on the fear that a default and Grexit would drive EUR/USD to 1.05. Talks completely broke down over the weekend on the back of this radical and incoherent move from Greece. In response, Eurozone Finance Ministers refused to extend the bailout beyond Tuesday. On Sunday, the Greek government moved forward with this plan by setting a date for the referendum (July 5th) and shortly after the European Central Bank refused to increase the level of Emergency Liquidity Assistance despite waves of withdrawals. In turn, the Greek government was forced to close banks for the next week, institute very low withdrawal (USD$66) limits, transfer restrictions and close the stock market, triggering widespread fear that a default and Grexit would be next.

So in a nutshell, the 3 reasons for the turnaround in the euro are the following:

1. Hope that a Deal is Still Possible or at least that an extension would be provided to cover referendum period

2. Swiss National Bank buying euros

3. Gaps filled on unwind of euro carry trades

The Greek government’s willingness to walk into the fire is a dangerous proposition for Europe and the global markets. We have already seen steep sell-offs European equities and the uncertainty in the coming days will lead to further weakness. So while the EUR/USD recovered, the decline in stocks and rise in bond yields is consistent with our view that the euro should be trading lower.

We have sold euros on this bounce and expect another move below 1.10.

In addition, the market’s appetite for risk has been completely changed by this latest chapter in the Greek debt crisis so not only do we expect EUR/USD to trade lower, but other high beta currencies could see further losses as well. If the sell-off gets out of hand, we could see the ECB step into the market and buy bonds but that would require a far more volatility. Aside from the financial crisis that Greece now faces, the other big uncertainty is the referendum. A yes vote would humiliate Mr. Tsipras and most likely lead to steps remove him from office but also prompt a deal with creditors. Political uncertainty is bad but a no vote would be worse because it would put Greece on the path to Grexit. In the long run, that may be positive for the Eurozone but in the short term, it would mean contagion for markets around the world.

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