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Europe’s – it’s either one thing or another

  • A wobbly day for the euro
  • S&P scuppers the dollar’s better tone
  • Greece may already be asking for a debt restructuring
  • Spain thrust back into the spotlight
  • Finnish election outcome is a blow for the euro

Guest post by FXPro

Monday was yet another wobbly day for the euro after Friday’s fairly indifferent performance. Whereas for most of the year-to-date, the single currency has been very much focused on the interest-rate story, this has shifted in recent days to the increasingly precarious situation developing in the eurozone periphery. The correlation between 2-yr interest rates and EUR/USD illustrates this well. In the first quarter the rolling 3-mth correlation between EUR/USD and the 2-yr interest-rate spread between the eurozone and US was near a 3-yr high around 0.56. Since Thursday we’ve seen a further modest widening in interest-rate spreads as European rates have moved lower, but the decline in US rates has outpaced this, which should have been euro supportive. Furthermore, comments from ECB officials over the weekend were certainly not standing in the way of further rate increases.


Meanwhile, the deterioration of financing conditions in the periphery, combined with the Finnish election result and talk of Greek debt-restructuring, have pushed out our aggregated measure of eurozone peripheral spreads near to the highs seen early on in January. There is a similar picture when comparing EUR/USD with SovX CDS index, which tracks a basket of CDS contracts on eurozone sovereigns, although this is still somewhat off the January highs. There are several reasons why they show a different picture (primarily because the CDS index gives an equal weight to all countries), but the upshot is that we’ve seen a shift over the past couple of sessions which suggest that the euro could, once again, be entering a phase of increased sensitivity to sovereign risks, rather than interest rates.


A better day for the dollar, for a change. Amidst the generalised risk-aversion that characterised trading on the first day of the new week, it was the dollar that was a major beneficiary. Indeed, the fact that the dollar essentially matched other safe-haven currencies such as the Japanese yen and the Swiss franc was noteworthy. As we have been remarking recently, this sudden loss of confidence in the single currency is not completely surprising, if only because euro long positions had become extremely elevated by historical standards – a week ago, traders and hedge funds held the largest euro long position since late 2007. Certainly, fundamental developments on Europe’s periphery have also played a part in the slippage of the single currency over recent days. However, the added dynamic of extended long positions has likely accentuated the pace of the fall. Numerous sell stops have been triggered, especially over the course of today’s session. Given the extent of the longs, it is likely that further significant stops exist at levels not far below current spot.


Dollar’s gain punctured by S&P’s negative ratings news. On a better day for the dollar, S&P scuppered the improved tone with the announcement that, although it was affirming the US rating, it was placing the US on review for a potential downgrade. Fiscal issues were cited as the major worry for the rating agency. It could be argued that this is about time – America’s fiscal predicament remains truly frightening.

Greece may already be asking for a debt restructuring. Despite furious denials by various government officials over the course of the weekend and on Monday, the sense remains that Greece may already be actively exploring the option of debt restructuring. Both the Greek dailies Eleftherotypia and Kathimerini suggested that Greek officials “raised the issue” of restructuring with the EU and the IMF in recent conversations, in particular the idea of extending the maturity of existing debt. The Greek 10yr yield soared another 60bp on Monday to 14.2%, while the 2yr yield rose through 20%. . Yet another development that is weighing heavily on the euro.

Spain thrust back into the spotlight. Spain was singled out for especially harsh treatment yesterday, with the 10yr yield out by 25bp vs. comparable Bunds from Friday’s close. News that Spanish house prices dropped a further 2.6% in the first quarter has triggered additional concern regarding the true state of the collateral of Spain’s banks. The Spanish Treasury also conducted an underwhelming bill sale where the bid/cover was down significantly on the last time.

Finnish election outcome is a blow for the euro.
Finnish voters threw a spanner in the works of the euro over the weekend after a surge in support for anti-euro parties. The populist anti-euro True Finns party garnered 19% of the vote and ended third in a very tight race, just behind the Social Democrats with 19.1% (supportive of the euro but critical of the aid package for Portugal) and the National Coalition with 20.4%. Over recent weeks a groundswell of opinion opposed to the mooted aid package for Portugal had been increasingly evident in Finland, borne out by the weekend poll results.

Finland is unique within the EU, in that it is parliament and not the ruling government that votes on EU requests for bailout funds. If Finland votes against the aid package for Portugal in its current form, then it could certainly delay the provision of funds and unsettle both the euro and peripheral bond markets. Talks on forming a new government are to be held in May. Given the strong showing of the True Finns, it is difficult to see how they could be left out of any new government. The situation in Finland is yet another source of concern for the single currency.


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