The European Economic and Monetary Union (EMU) has been under significant stress since the outbreak of the Greek crisis.
More than a year later, the EMU's future remains uncertain.
Three broad scenarios can be envisaged: full fiscal union; muddling through, which involves two possible scenarios; and a worsening crisis that threatens the EMU's existence.
Scenario 1: Full fiscal union and creation of a eurobond market (10 to 20 per cent probability).
This scenario can be seen as the most positive for financial markets and particularly for risky assets.
A rapid decrease in volatility and an increase in risk appetite is expected in this case, as well as declining liquidity. A rally in all risky assets (stocks and credits) would probably follow, with rapid spread narrowing on corporate bonds as well as emerging-market and high-yield bonds, as the European Central Bank (ECB) would be likely to keep interest rates unchanged.
Scenario 2a: "Muddling through" with slow resolution of Greek debt (30 to 40 per cent probability)
The first "muddling through" scenario can be described as: controlled Greek debt restructuring in several stages - erratic, grinding, slow recovery of confidence, with setbacks spread out over a long period, since the underlying debt problem is not resolved.
This scenario would also mean changes to the European Financial Stability Facility (EFSF) are approved in the course of the autumn; fiscal consolidation plans implemented in high-debt countries, potential international add-ons to EFSF at later stage; bank-sector recapitalisations in Europe where needed; the ECB providing continued "bridging" support and perhaps cutting interest rates.
EMU growth slows because of more restrictive fiscal policy, but recession is avoided thanks to easier monetary policy; growth in the US, Japan and Europe stays structurally low, but recession is avoided.
Scenario 2b: The second "muddling through" scenario involves a large, end-of-year Greek debt restructuring (30-40 per cent probability).
This scenario, which we regarded as one of the most likely, is gaining traction.
The likelihood of a restructuring this year of Greek debt that goes beyond the terms of the current debt exchange with a haircut of 50 to 60 per cent has increased.
Such a scenario would consist of: substantial initial increase in risk-aversion as bank stocks would remain under pressure, and a restructuring of other weak countries' debt, such as Portugal's, could not be excluded; bank sector recapitalisations in Europe with potential Euro-Tarp (troubled asset relief programme) and foreign (Gulf, Asia) participation would be necessary and be part of a "grand solution".
This scenario would also mean: the newly expanded funding capacity of the EFSFwould be increased further; the ECB steps up its "bridging" support (large-scale purchase of peripheral sovereign bonds), providing unlimited liquidity to the banking sector and possibly cut interest rates; fiscal consolidation plans would still have to be implemented in high-debt countries.
In a second phase, this scenario would contain a bullish aspect as it would put Greek public finances back on a sustainable path, with Greece staying in the EMU.
As in Scenario 2a, it is expected that EMU growth would slow due to more restrictive fiscal policy, but recession to be avoided due to easier monetary policy.Recession would be avoided thanks to easy monetary policy, resilient non-financial corporate earnings and robust emerging-market economic growth.
Scenario 3: Worsening crisis, possibly leading to EMU break-up (10 to 20 per cent probability).
This scenario could include a moderate worsening or a more dramatic outcome. The exit of one country (Greece) from the EMU would lead to temporary turmoil; the exit of Germany or others would cause a major crisis.
In the worst case, the following could be expected: acute collapse of trust in Europe leading to credit crunch and global recession; default of weaker euro-zone countries; deposit freezes to avoid bank runs; a "new D-Mark" in Germany would appreciate sharply, and a "rump euro" would depreciate sharply.
The ECB would need to provide massive liquidity to support banking systems; other central banks would also need to provide support.
Scenario 1, a full fiscal union and the introduction of a eurobond market is the most favourable but rather unlikely scenario. The least desirable outcome is Scenario 3. The reality is likely to be somewhere in between these two outcomes.
* This article has been jointly written by Credit Suisse executives Nannette Hechler-Fayd'Herbe, Giles Keating, Michael O'Sullivan, Dan Scott and Oliver Adler