April 08, 2010

Is there a winner in Europe’s Sovereign Debt Crisis?

Just when we thought that Greece had finally taken care of funding its liabilities and convinced the EU and the IMF that their austerity measures would put an end to most of the concerns about a Greek default, it turns out nothing has really changed.  Greece appears to be unable to bolster its finances and to adhere to the austerity measures announced last month.   Instead, Greece has been promoting itself as an emerging market economy and is now targeting U.S. investors in a $5B-10B bond sale to help cover its May borrowing requirement of about €10B.  

Bad news from Greece instantly translated into market reaction.  Today, the yield on 10-year Greek government bonds rose above 7%. The closely watched spread between Greek and German 10-year debt increased to above 4 percentage points.  Combine that with the flat Eurozone GDP numbers for Q4-2009 and the forecast that GDP growth in Europe’s powerhouse Germany is going to be benign at best and you have a recipe for an ongoing Euro crisis.

Not surprisingly, the Euro has been taking a hit and is now essentially back to square one, around the same level of late March before an EU wide support for Greece was announced.  Whether the 14 month technical low of the Euro versus the US$ at 1.3265 area will hold depends very much on how the Greek debt crisis plays out and whether there are any major fall-outs from the so-called Club-Med countries (Portugal, Spain, Italy) who are rumored to be similar financial shape as Greece.


Is there a potential winner from this Euro upheaval? 

The Euro certainly remains under pressure but much less publicized and yet much more vehement was the decline of the Euro versus other major currencies.  Topping the list is the cross-currency trade Euro versus Australian Dollar.  We previously looked at this currency pair a couple of weeks ago when the Euro hit a new  13-year low of 1.4605 versus the Australian Dollar. Since then, the Euro slid another 300 points to a low of 1.4348, a level not seen since August 1997, and bringing the Euro within a hair of the all-time low of 1.4025.


While the speed and intensity of the decline continues to baffle there are additional factors which paint a slightly rosier picture for Australia’s currency compared to the Euro. After the Australian Reserve Bank announced the 5th quarter percent increase in their cash rate earlier this week, Australia now enjoys a 3.25% spread over European deposit rates making the rationale for a carry trade against the Euro as a funding currency even more plausible than before. 


And, as a traditional commodity currency, the Australian Dollar could also enjoy further gains on the back of an increase in commodity prices, particularly the metals and other raw materials which Australia has an abundance of and which seem to be in big demand by many countries in the Far East.

Having said all that, 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 – and I realize I am repeating myself here.  There has been no significant technical correction to speak of since this dramatic currency slide began in February 2009, which poses the question as to when the major net sellers of the Euro would cover their short positions. 

Yet, as long as the Greek debt crisis continues and while there is even a remote likelihood of a possible spill over towards other Southern European member nations, the Aussie Dollar is definitely an appealing alternative to an international investor via the favorable deposit rates.  Much of the Euro-woes may have already been priced in by now, bearing in mind the severity of the decline thus far.  But as long as serious doubts about the continued existence of the Euro remain, one should consider expressing that opinion via the cross currency trade rather than the more commonly known Euro versus US Dollar trade.

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