EUR: Greece remains the focus

The outcome of the weekend's political meetings regarding Greece's latest proposal to creditors will be an important driver of the EUR in the first part of this week. The EUR's reaction is likely to be asymmetric - a rejection of Greece's proposals by the creditors will likely drive a sharper sell-off in the EUR than any rally under a more positive outcome. First, the market is poorly positioned for a negative outcome as price action on Friday was consistent with a high degree of optimism as European equities rallied, peripheral European bond spreads narrowed, EUR rallied and EUR implied volatility fell. Second, the first line of defence against contagion is likely to be the ECB's QE programme, with the ECB possibly frontloading some of the purchases to mitigate widening periphery spreads. A frontloading of EGB purchases will likely drive a sharp fall in the EUR.

In this respect, Thursday's ECB meeting will likely see President Draghi answer queries about Greece, eg, the ECB's stance on the ELA for Greek banks, and policy responses should financial market/economic conditions deteriorate and contagion intensifies. 

"We do not rule out ECB responding with measures before the Thursday MPC meeting should market conditions deteriorate rapidly under a 'no' outcome for the third bailout negotiations on Sunday. We see the market underpricing the risks of increased volatility and continue to recommend staying short EURUSD spot", says Barclays