Euro holds steady in face of Greek drama

Despite the increasingly desperate situation in Greece, the euro is holding on pretty well.

After talks broke down over the weekend, Greece looked like missing a key debt repayment that would unlock more bailout funds to keep the troubled economy afloat.

Stocks plunged rapidly on Monday and the euro dipped to a four-week low versus the dollar. But the single currency remains ten per cent above its 2015 nadir and is managing to remain fairly steady in the face of Greece’s problems and the prospect of the country becoming the first to leave the eurozone.

“The resilience is perhaps surprising and suggests that market participants are confident that any contagion risk can be managed,” commented Adam Chester, head of economic Research & Market Strategy at Lloyds Bank Commercial Banking.

However, the situation is fluid and the outlook for the single currency is a tricky one to predict.

“It could be, of course, that with many investors already sitting on large euro short positions, they are wary of adding to these given the degree of uncertainty,” adds Chester. “This could easily change as the balance of news breaks over the coming minutes, hours and days.”

With capital controls introduced in Greece and the country’s banks closed until after the July 5th referendum, there could be lots more “euro-inspired currency volatility”, says Chester.

He says there is lots of room for the currency to weaken more - EUR/USD approached parity earlier in the year, although this was more about dollar strength than euro weakness. However, the direction the euro takes over the coming days and weeks will depend on what happens in Greece.

“Developments over the coming week could remain extremely fast moving. Given the uncertainty, more importance should be attached over the near term to the risks rather than the central view,” he adds.

The euro is being dragged lower versus the dollar for another reason, quite apart from the Greece drama. The US Federal Reserve is increasingly looking like it may hike interest rates in September, a move that would strengthen the dollar.

“Over the medium-term, we expect the euro to depreciate due to monetary policy divergence,” says Mark Burgess, CIO EMEA, at Columbia Threadneedle Investments.

Greece leaving the eurozone - which a rejection of the bailout terms put forward for the July 5th vote would almost certainly entail - would certainly be bad for the single currency. But the situation is more complex and harder to read than it appears.

“A Grexit scenario should in our view be negative for the euro as the fundamental viability of the monetary union is called into question,” adds Burgess. “However, the reaction of the euro to recent turbulence has been somewhat unpredictable, at times appreciating on bad news.”

Greece leaving the eurozone could trigger a wave safe haven buying, which could delay the Fed’s interest rate hike plans. US equities have already taken a beating from Europe’s troubles and the US central bank may be reluctant to add to the market turmoil by increasing rates.