Should the markets be worried about Greek political turmoil?

In recent weeks the Greek crisis has receded into the distance, other concerns such as the volatility in the Chinese stock market and the timing of a potential first rate hike from the Federal Reserve have taken centre stage and the dominated market action.

Understandably, once it looked like Greece would be able to secure a third bailout and accept its creditors conditions the markets started to look elsewhere for market-moving events. However, now the spectre of more Greek woe is upon us once again as a political split within the Syriza party threatens to throw Athens’ third bailout into disarray.

The latest news from Greece makes grim reading:

• PM Tsipras is coming under attack from the “radical” element within his party for agreeing to conditions in return for more bailout cash.
• The new bad boy in Greek politics, Panagiotis Lafazanis, is leading the Syriza stance against Tsipras. He is leading up a faction within Syriza called Left Platform – the new thorn in Angela Merkel’s side.
• A meeting scheduled by Tsipras to address Syriza’s central committee on Thursday, ended in chaos with Tsipras eventually calling a referendum of Syriza party members on Greece’s latest bailout agreement.

Another referendum:

Oh yes, a month on from the last one, Greece is holding another referendum on Sunday 2nd August. This is only for the Syriza Party, and won’t hold the same weight as the national referendum, however it is asking the same question: a yes-no vote on the latest EUR 86bn bailout.

Even though this is not a national bailout, if Tsipras loses the referendum and the support of his party it could lead to a political meltdown, with the Syriza party losing its parliamentary majority, Tsipras stepping down as PM, and fresh elections being called. If this happens then the entire 3rd bailout would be unlikely to go ahead, leaving Greece at risk of further defaults in the coming days and weeks. It’s hard to tell what it would mean for Greece’s EU bridging loan, which is currently the only financial support Athens receives. If Greece’s creditors pull the plug on the bridging loan then it’s hard to see how Greece can avoid a Grexit in the coming months.

Grexit risks never too far away

As you can see, Greece is definitely not out of the woods yet and its financial future is still not secure, which is why we will watch the outcome of this Sunday’s referendum closely. If Tsipras loses the vote and Syriza votes No to the bailout, then it could mean a few things for the financial markets including:

• Excess volatility in global financial markets in the coming weeks. Combined with recent volatility in Chinese markets, it could make August a rough-ride for investors.
• Will the Fed hike interest rates if a Grexit is on the cards? We think not and it could eradicate the prospect of a rate hike from the Fed or the BoE for the whole of 2015.
• Europe would be at risk of another recession, especially if peripheral bond yields start to rise.
• The EUR could come under sustained attack if a Grexit makes the ECB commit to extending its QE programme.

Overall, the risk from an adverse outcome to this referendum is higher levels of stock market volatility, which, outside of Asia, has receded in recent weeks. It could also trigger a prolonged downturn in the EUR. The single currency was suspiciously resilient during the peak of the Greek crisis in June and early July, however, the downfall of the Tsipras government could be the canary in the coal mine, and finally tip EDURUSD over the edge. 1.0850 has held as solid support since May, a break below here opens the way to 1.0500 – 2015 lows – then potentially to parity.

Conclusion:

Who would have thought that Tsipras would turn out to be a pragmatic politician, but that is the way it is looking. He has lambasted party members who don’t agree with the bailout, saying that they do not appreciate the perilous situation that Greece finds itself in. The very fact he had to call a referendum is a sign that investors should not lose sight of Greek risks, even when the focus is on China and the timing of a US rate hike.

If Syriza votes No to the bailout on Sunday, it could make for a very volatile first trading session in August.