Grexit schmexit

Muted markets validate EU hardball with Athens

Muted markets are validating the Euro zone's hardball approach to Greek debt talks. Next Sunday's referendum could force the country to leave the single currency. Yet, markets are trading shy of full crisis levels. It eases the pressure on Euro zone politicians to offer sweeter terms to Greece's leader, Alexis Tsipras.

Greece's looming referendum means its position in the Euro zone is more fragile than ever. Yet, market moves suggest mere dismay rather than all-out panic. Stock indices have fallen, particularly in other southern European states like Spain and Italy, but are above levels in mid-June. They are well ahead of where they were at the start of the year, before the European Central Bank (ECB) began printing money.

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The pattern is echoed in bond markets. Yields on southern European states' sovereign debt jumped in early trading on Monday, but have since settled. Spain, seen as vulnerable because of its own rising populist party Podemos, has seen its 10-year spread over German debt jump around 30 basis points to about 1.5 per cent. That's enough to dampen the benefit of ECB bond-buying, but far from 2012 peaks of over six per cent. So too implied volatility in euro-dollar options, which spiked initially to 2011 levels but has since fallen.

If a Greek exit from the Euro zone actually happens, full-blown panic may set in. Exit would make it harder for countries to adjust, further straining Euro zone unity.

If there was a wider and deeper sense of alarm, Euro zone leaders might have felt obliged to offer Greece sweeter terms ahead of the referendum, such as debt relief. US Treasury Secretary Jack Lew has already called for it.

Euro zone leaders are in a bind. They want to keep Greece in the Euro zone, but don't want to reinforce the position of Alexis Tsipras, who might still lead Greece after the referendum. Offering much better terms now could increase euro break-up risks in the medium term because it could leave Tsipras in charge and encourage populist parties in other parts of Europe.

Things can change quickly. But so far the market reactions are helping Brussels more than Athens.