Greece plunged into chaos following a sweeping leftist election outcome that rejected its two major ruling parties and placed in jeopardy an international bailout put in place to keep the euro together.
On the surface, one would hardly take this as a buy signal for the currency. However, many investors were doing just that on the belief that Greece would be forced to exit the union, leaving the euro stronger over the long term.
“It may be the case that in the future, only those that can live with the stringency of the conditions required to keep the show on the road will be in the euro,” said Jim O’Neill, chairman of Goldman Sachs Asset Management.
“On the basis that this will only be those countries that have the largest influence, and clearly centered on Germany, perhaps the markets are ‘right’ to look through some of the ongoing concerns about a number of the smaller countries and disregard whether they stay or go. Following this line of reasoning, since the combined weight of Greece and Portugal in the euro area is less than 5 percent it may not be a big deal if they leave.”
The euro plunged to a three-month low following the Greek results, along with a win by the Socialist candidate Francois Hollandein France. But the currency cut those losses by two-thirds against the dollar by the time U.S. markets opened. The S&P 500 , whose overnight futures were down more than 1 percent following the result, briefly traded positively Monday.
“Long term, a Greek exit would be bullish for everyone,” said Mitch Goldberg, President of ClientFirst Strategy. “Germany will support Greece to make the transition as smooth as possible. The best way to strengthen a chain is to remove the weakest link.”
Greece had worked out with the Troika (the European Commission, the European Central Bank and the International Monetary Fund) a rescue package contingent on the government implementing austerity measures that would make for budget savings that total 7 percent of GDP over each of the next two years.
“The outcome of the Greek election shows that it will be very difficult to form a viable coalition and to implement the measures required,” said Citigroup Economist Guillaume Menuet, who increased his chances of a Greek exit to as high as 75 percent from just 50 percent before the elections.
If the Troika stops its upcoming bailout payments as it waits for a coalition to get its act together, the Greek “banking sector would run out of funding. As a consequence, we expect that Greece would be forced to leave the euro area.”
To be sure, many traders chalked up the euro comeback to short-coveringfollowing the completion of this widely-anticipated bearish event by hedge funds who had stacked up bets against the currency before these elections.
Others strongly cautioned against a long euro trade here, citing the broader implications an exit by any member – no matter how small -- would have on other weak members of the union.
“If Greece were to leave, pressure on Portugal and others in the periphery, would likely grow, not diminish,” wrote Marc Chandler, Brown Brothers Harriman global head of currency strategy, in a note to clients. “If Greece does leave the union, some expect the Euro to rally. We are more skeptical.”
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