Trade the Greek Elections from the Long Side
Given all the possible scenarios for the Greek elections, it is a good possibility that the markets will rebound, not crash, following the elections, because Greece is likely to stay in the Euro for the time being regardless of the election outcome. The most likely outcome is a compromise that reaffirms a commitment to austerity while offering up some growth initiatives and giving Greece and other bailout recipients more time to meet debt and deficit targets.
If Greece to stays in the Euro and the new government tries to muddle through for the time being, European equities would rally 5% to 10% percent and the Euro will rebound, triggering similar rallies in U.S., U.K. and Japanese equities. If central banks are worried enough about possible negative outcomes, their clearer commitment to providing liquidity would support a more extensive short-term rally. It is highly unlikely that Greece immediately abandon the Euro and re-introduce the Drachma. The new, presumably weak government would have to manage a potential sovereign default, plan a new currency, implement a plan to recapitalize the banks, stem the outflow of capital and pay bills once the bailout lifeline is cut....all seriously challenging for even a strong government.
Beyond the relief bounce, however, risk assets are still basically in a downtrend and Greece is fiscally and financially toast. According to Greek bankers, some 800 million Euros (USD 1 billion) is being withdrawn from major banks daily, some of which they are using to stock up on daily necessities.
a) It doesn't matter if Greece doesn't agree to unconditionally implement the Euro Troika's reform program, because any new government will essentially be incapable of implementing the required austerity even if they agree to the conditions for further bail-out funds. If the Syriza or other parties were to win but fail to form a coalition government, the Greek constitution says that the new president must broker a government of national unity. If this can't be done, new elections must be held, which is what happened after the May 6 election, meaning Greece could run out of money anyway as the Euro Troika has no Greek government to deal with and would stop providing funds. The crisis continues, forcing a a re-negotiation of the conditions of further bail-out money. Even if the New Democracy party wins big, Greece’s problems are so challenging that there's a good chance it will get pushed out of the Euro in the next year anyway. However, as a Greek exit from the Euro could in fact mean the end of the EU, Greece's Euro peers will try to delay the exit to prepare financial markets for the inevitable deflationary shock.
b) The Euro crisis contagion has already long since moved on to Spain (the Union's #4 economy) and is rapidly encroaching on Italy (the Union's #3 economy). Euro zone finance ministers rushed Spain into a EURO100 billion (USD125 billion) EU-funded rescue for its debt-stricken banks aimed at pre-empting the threat of a bank run. The rescue plan failed to alleviate financial market pressure on Spain, because the measure is a mere band-aid for Spain's fiscal and economic problems. Thus Spain is the real eye of the Eurozone crisis storm.
a) The U.K. is attempting to proactively ring-fence the U.K.'s double-dipping economy from the Euro crisis specter, with the government and central bank moving to flood Britain's banking system with more than GBP100 billion (USD155.43 billion). The BoE sees the Eurozone crisis as the catalyst for a crisis of confidence in the U.K., which was leading to a self-reinforcing weaker picture of growth, and a U.K. government implemented tough austerity plan of tax hikes and spending cuts aimed at erasing a budget deficit which still comes in at around 8% of GDP.
b) Eurozone officials have been working for some time on emergency planning to contain the fallout from a Greek exit from the currency bloc, including the preparation of emergency scenarios by EC and ECB staff as well as national finance ministries. This contingency planning reportedly goes as far as restricting ATM witdrawals, restricting travel in the EU and capital controls, but also includes ECB rate cuts and so-called QE operations as well as a re-start of its dormant bond-purchases program.
c) The U.S. Fed ostensibly stands ready to provide abundant currency swaps to avoid a sudden shortage of USD in Euroland, and stands ready to adopt additional accommodative measures if downside risks from the Euro crisis become "large enough".
The problem of course is, just what is "large enough". If these central banks, including the BoJ are worried enough about the fallout from Greece, or just as importantly, an accelerating crisis in Spain that spills over into Italy, the "dead cat bounce" in the Eurostoxx 50 and EUR/USD could be more extensive.