Eurozone leaders carry on muddling through

 
Louisa Bojesen
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AS the weeks go by, the chances of a Greek default are getting higher. The vast majority of guests on my CNBC show agree: something has to give. The sovereign debt crisis is here to stay, and there will be many more conference calls to come.

So what are the various potential outcomes? And how will they affect the markets? This is exactly what Michael O’Sullivan, head of portfolio strategy at Credit Suisse, has tried to work out. Below are what he sees as the possible scenarios.

FULL FISCAL UNION AND EUROBONDS
O’Sullivan says that this scenario would be the most positive for financial markets, especially risky assets. Here, the euro would appreciate, while the dollar and the Swiss franc would depreciate.

Also, an increase in German, Swiss, and US government bond yields could be expected as investors sell out of safe-havens.

EUROZONE MUDDLES THROUGH
The Eurozone monetary union tries to contain the crisis, leading to a slow, erratic recovery in confidence.

This, according to O’Sullivan, is the most likely scenario, and can essentially be summarised as “controlled Greek debt restructuring in several stages”.

The ECB and bailout funds would buy Italian and Spanish bonds to stop contagion. Under this scenario, US and emerging market equities outperform, market volatility gradually moves lower, bund yields stay relatively low, and currencies remain pretty range bound.

EUROZONE DRAGS FEET
Market turbulence worsens, forcing a more radical Greek debt restructuring; significant bank recapitalisation; and a sharper recovery of market confidence.

Under this scenario, there would first be a period of strong “risk-off”, followed by a large “risk-on” phase. First, benchmark government bond yields will fall, but after that there will be a period of normalisation. Equities will underperform until banks are properly recapitalised.

EUROZONE BREAK-UP
This is the worst case scenario: a major, global economic crisis would develop. As written in the Credit Suisse report: “The exit of Greece from EMU would lead to temporary turmoil, the exit of Germany or others would cause a major crisis.”

This case would lead to “risk off” investing. There would be a lot more market volatility, and it is likely that European equities would re-test the 2009 lows.

There would be a rally in benchmark government bond yields.

For now, though, we muddle.

Louisa Bojesen is an anchor at CNBC. Follow Louisa on Twitter: @louisabojesen