Greece Plummets on Early Elections, Raising Worries About ECB QE

Greece was back on traders' radars Tuesday as the Athens Stock Exchange crashed nearly 11 percent in early trading, while 10-year government bond yields rose to over 7.5 percent. Downside comes as the Greek government announced yesterday that the Presidential elections will take place in December instead of February. The timeline, according to analysts, complicates the discussion on sovereign quantitative easing (QE).

The election will take place in three rounds, Dec 17th, 23rd, and 29th. The first two rounds need a two third parliamentary majority, while the third one needs a three fifth majority (or 180 votes).

Bank of America Merrill Lynch's Gilles Moec notes the government's move followed the Eurogroup's decision to extend the discussions of the current review and therefore the current program by another two months, because of failure to agree on the review. The review requires very unpopular measures. There are two possible outcomes. 1) To elect a president and avoid elections, or for Samaras to win the elections if he fails to elect a president, and then conclude the program review having earned the mandate to do so; or 2) Syriza wins and they are in charge of the complicated negotiations ahead with the Troika.

Moec sees a binary outcome. "If the government avoids early national elections, what will follow will be the conclusion of the program review and the beginning of discussions for an official sector debt relief. If we get early elections, Greece could potentially face political paralysis and even possible default. A Syriza government will not have much time to renegotiate with the Troika. In any event, a Syriza government will likely have to agree on exactly the same deal that the current government has found politically difficult to agree with, or Greece would enter a new period of substantial uncertainty and volatility, with tail risk scenarios coming back to the fore."

Commenting on if the elections matter for their call on ECB sovereign QE, he weighed in:

Case 1: If the election results come by 22 January (next ECB meeting), this would play in the hawks' hand against QE to the extent that a potential Greek default would materialise the possibility of a loss at the ECB (equally shared among the member states according to the capital key).

However, QE is a monetary policy decision which is primarily driven by the need to deal with deflationary pressure at the euro area level. It would be disputable, to say the least, to "penalize" the rest of the Euro area of extra support from the ECB on account of the behaviour of one country.

In addition, the doves would probably argue that QE would be even more necessary than before to prevent any contagion effect from Greece to the rest of the periphery. Indeed, in our view a potential Greek default would trigger a significant rise in the risk premium throughout the periphery if the ECB is seen as hesitant to purchase bonds. If QE becomes unpalatable, the market will soon remember that OMT- the default instrument to deal with fragmentation - is immensely more complicated than it seems: given the political difficulties in most peripheral countries at this stage, the probability of getting the sort of deal on fiscal policy and structural reforms OMT demands would be low, especially at short notice.

Finally, the ECB could still be protected against any further loss on Greece originating from QE since they would - following Constancio's suggestion last week - buy non-IG bonds only if the sovereign is under a programme.

Case 2: If the elections take place after 22 Jan, then it can be tempting for the ECB to wait until 5 March and have a better picture of the situation in Greece. But again, especially if it's clear that in any case the Central bank would buy GGBs only if there's a program, by delaying QE the ECB would take the risk of triggering a significant upset in the whole periphery, while continuing to fail on their mandate - price stability. In addition, it can actually be an argument for Samaras' coalition: if the ECB threatens to stop buying if Greece exits the program, this may actually have an impact on the choices of the Greek electorate.

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