March 23, 2010

The Euro Weakness In A Different Light

On the back of continued wrangling over a possible Greek bailout by Germany (or the IMF), currency players have been shorting the Euro with renewed rigor.  European equities remain fairly upbeat so far with the German DAX only 1.3% below its 52-week high at present. The fact that Greek 10-year Bonds are still yielding 6.34%, about a 3 1/4 point spread over German 10-year Bonds, clearly shows the current investors’ tendency towards quality and safety over risk.  That same need for quality and safety is currently not associated with the single European currency which is all to apparent in the renewed decline of the Euro versus the US Dollar.

A little less publicized but much more vehement was the decline of the Euro versus other major currencies.  Topping the list are the cross-currency trades Euro versus Australian Dollar and Euro versus Swiss Franc, both of which may have emanated from a different rationale.

Let's examine the Euro versus Australian Dollar first.  The Euro hit a 13 year low of 1.4665 versus the Australian Dollar in early Australian markets today. The single currency has now lost over 26% in the past 12 months and the speed and intensity of the decline has been rather troubling.  Australia still enjoys a healthy 3% spread over European deposit rates making it a preferred target for a carry trade against the Euro as a funding currency.   But the Australian Dollar has now gained so much against the Euro that one might hesitate to put on a trade that may have already run most of its course.  There has been no significant technical correction to speak of since this dramatic currency slide began last February, which poses the question as to when the major net sellers of the Euro would cover their short positions. 


One could equally assume that possible deflationary pressures on commodity prices may weigh on the Australian Dollar, which typically correlates closer to the commodities than any other currencies. However, that has not happened yet either. Moreover, technical factors continue to favor the downside with possible targets at technical support of 1.4605 and at the all-time low of 1.4025 which looks increasingly likely now. 


Turning our attention to the Swiss cross trade, in the overnight Australian markets the Euro fell to a 25 year low of 1.4232. In the absence of previous reference points (our charts only go back to 1984), we are entering somewhat new territory here. 


The Euro’s slide against the Swiss Franc by contrast to the Aussie, has not been quite as fast or as drastic and the rationale for favoring the Swissie over the Euro is slightly different from that of the Aussie $.  For starters, the Swiss currency has even lower deposit rates (0.25%) than the Euro (1%), so the carry trade is out.  Further, the Swissie is not exactly a commodity type currency and it is not nearly as important in terms of international trade.  However, it has historically been considered a safe-haven currency, perhaps a bit tainted after some heavy arm twisting by the US government that led to a partial lift of the Swiss banking secrecy laws, but nevertheless, it is a “neutral” country.  That neutrality would play well and as long as the Euro member countries are trying to sort out their issues. 

In the meantime, there is not much that speaks for a reversal of these two cross trades just yet.  The market sentiment is clearly against the Euro at the moment.  Although one might be concerned about a possible reversal of the speculative shorts against the Euro, until the Greek debt crisis is settled the Euro will have a hard time slowing down or even reversing the trend.  In times of trouble, stay neutral which means continue favoring the most neutral of all countries.  In the absence of a deterioration of the Greek debt crisis and a possible spill over towards other Southern European member nations, one should consider favoring fundamental reasons over neutrality.  As time passes, the Aussie Dollar might be the better fundamental trade via its favorable deposit rates over a much more neutral stance via the Swissie.

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