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EUR: Counting Down To Default?

Kathy Lien, Director of Currency Research, GFT





  03/13 Meeting 04/25 Meeting
NO CHANGE 46.0% 46.2%
CUT TO 0 BP 54.0% 52.9%
HIKE TO 50BP 0.0% 0.9%



Having consolidated for the past month, the EUR/USD finally broke out to upside rising to its highest level this year. The rally in the currency could easily lead investors to believe that the risk of a Greek default has declined but unfortunately it has not. In fact even Greek Finance Minister Venizelos believes that the CDS will be triggered. This means investors are buying euros not because default risk has decreased but because they have grown more comfortable with the possibility of default. The market is currently pricing in a 90 percent chance of a Greek default and with the Finance Minister downplaying the significance of CDS activation, it appears inevitable. On Wednesday rating agency Fitch said that once the debt swap is complete, it will place the country on restrictive default. Greece is already one step closer to default after passing legislation to force losses on bondholders refusing to participate in the swap. They have 2 weeks to tell if the swap is voluntary or not. From February 24th (Friday) to March 9th, Greece will formally offer its debt swap and bond holders would exchange their bonds between March 9th and March 12th. Under the terms of the deal, private investors would swap their current bond holdings for new Greek bonds and notes from the EFSF worth only 46.5 percent of the par value of their current Greek bonds. For the first 8 years, the weighted average coupon rate will be 2.6 percent and for the full period 3.65 percent. The lack of attractiveness could deter some investors from accepting the deal which is where it all gets tricky. Greece says all they need is two thirds participation to make the offer voluntary and depending on the participation rate, Greece could activate the CACs. A major bank or hedge fund would then need to request that a credit event be triggered and ISDA would review and vote on the request. If the take up rate is less than 66 percent, a default would trigger almost automatically.

The question then becomes how much of an impact a Greek default would have on the markets. Psychologically it would be significant because it is a first for the Eurozone. Fears of contagion could freeze the markets quickly as investors turn their focus to the risk of contagion. If a default were to occur, the euro and European financial markets would take their cue from European yields and the CDS spreads of Italy, Spain and Portugal.  The next 2 weeks will be extremely important to Greece and the financial markets as a whole but from now until then, things could be quieter unless the second bailout fails in any Parliamentary vote. Germany will be holding a vote on Monday and Merkel won’t gain support from local lawmakers easily. In early March, European Union leaders will meet to give their final seal of approval for the deal.  Although we believe that a default would have significant repercussions for the euro and the financial markets in general, it may not mean the end of the world. Investors survived the U.S.’ loss of their AAA rating and the downgrade of France – they even survived the demise of century old Wall Street institutions, albeit after some severe pain. If Greece were to default and credit default swap payments were made, at least faith in these instruments would be restored and investors would not have to wonder if banks, policymakers and ISDA will bend the rules in a crisis.

With 2 weeks to go before we get any information on the participation rate, the EUR/USD could still extend its gains. Today’s breakout has been strong and a successful approval of a second bailout in Germany next week could propel the currency pair above 1.45.


Although equities rose only slightly, investors are feeling a bit more optimistic today which explains why safe haven flows have eased out of the U.S. dollar.  The greenback traded lower against all of the major currencies including the Japanese Yen which had enjoyed a 5 day winning streak.  A healthy jobless claims report contributed to the improvement in risk but failed to lend support to the dollar. Jobless claims held steady at 351k which is unchanged from last week's upwardly revised report - the revision was small, from 348k to 351k. Although fewer claims do not translate directly into greater job growth, as long as claims hover around 350k, it is consistent with an improving labor market. For the Federal Reserve, this means that there is no immediate need to increase stimulus which is good for the U.S. dollar, particularly USD/JPY. After rising for 5 consecutive trading days and enjoying a rally with virtually no correction since the beginning of the month, USD/JPY is finally meeting some resistance. Despite a relatively good jobless claims report, USD/JPY failed to extend its gains. From a fundamental perspective, we could see USD/JPY rise further as low jobless claims boost interest rate expectations and U.S. yields but after such a strong rally, a correction, large or small is overdue. New home sales are scheduled for release on Friday along with the final University of Michigan consumer confidence number. January was a better month for the housing market and we expect this rebound to be reflected in the new home sales report. According to the Federal Housing Finance Agency, house prices rose 0.7 percent in the month of December which is consistent with a slow and gradual recovery.


The British pound strengthened against the U.S. dollar but weakened against the euro. Concern by a U.K. policymaker prevented the pound from enjoying as strong of a rally as other major currencies. This morning, Bank of England member Miles said that the U.K. economy is still in a very precarious situation and there has not been much of a recovery. He expects wage settlements to remain subdued and for this reason, the BoE needs to maintain a very expansionary monetary policy stance. The central bank has overlooked every improvement in U.K. data because they are wary of the risks in the Eurozone. The country’s factory order index rose to a 6 month high according to the Confederation of British Industry. The CBI Total Trends index rose to -3 from -16 in the month of February. This is a strong sign of improvement for the manufacturing sector and according to the details of the report the country has exports to thank. Domestic and overseas demand has strengthened which helped to boost manufacturing conditions. Prices on the other hand have declined keeping the BoE’s concerns about inflation intact. Loans for house purchases also rose to its highest level since December 2009 which is a sign of improvement in the housing market. Unfortunately according to the latest BoE minutes, the central bank is still dovish and open to the idea of raising asset purchases even further and until this sentiment changes, the pound will have a tough time rallying.


All three of the commodity currencies traded higher against the US dollar. The improved market sentiment facilitated the rise in the AUD, NZD and CAD. Despite its intraday volatility, USD/CAD has found some support around parity.  Low interest rates have led to an increase in household debt - Governor Mark Carney has sounded numerous warnings that the record level of household debt could be detrimental to Canadian economy. Much of the growth in debt has come from borrowing against the value of their homes. The home equity line accounted for about half of consumer credit in 2011, up from 11 percent in 1995, the bank said in its report. As house prices cool in Canada, households could end up with more debts on their balance sheet. This leveraged balance could in term slow consumer spending, which the central bank is counting on to fuel more than half of the economic growth this year. According to BoC’, simulation results suggest a 10% drop in house prices could lead to consumption declining as much as 1%. In Australia, there is a similar story. The country’s household debts have been around 150 percent of disposable income since 2006, according to Reserve Bank of Australia. While many of the developed countries are tightening their belts, the Australians did not undergo a complete deleveraging process. The over-extended balance sheet could limit the ability to sustain economic shocks if the growth slowed in China, one of Australia’s largest trading partners. On the other hand, New Zealand Finance Minister Bill English remains confident about the country’s recovery. English expects the rebuilding of earthquake-stricken Christchurch to add 1.25 percentage points to annual growth every year from 2012 to 2016. Furthermore, as New Zealand only exports 20 percent of goods to Europe and the US, the Greek crisis could have a lesser effect on its economy. Looking forward, with no economic data tomorrow, the trading in comm. dollars could hinge on the headline news in the US and Europe.


The Japanese yen weakened against all of the major currencies today with the exception of the US dollar. After breaking the 80 handle, there was a pull back in USD/JPY. Since Bank of Japan’s unexpected move to increase stimulus, the one-sided momentum has significantly weakened the yen versus the greenback. Central bank governor Masaaki Shirakawa stressed BoJ’s determination to achieve their price target in front of the parliament. "The BoJ, under the inflation goal of 1 percent, will continue its powerful easing for the time being. This strong resolve is not just mine but it is the will of the nine-member board,” said Shirakawa. Furthermore, the governor commented that the bank would not back track its easing policy if prices rise due to higher oil prices. However, Keisuke Tsumura, a member of the lower house of parliament and a former official at BoJ, voiced the concern that additional easing could cause havoc in the bond market. "It might be too much to call the current situation 'the bubble of government bonds' created by such easing competition, but there is a concern that such easing may mask risk premiums and cause distortions in the bond markets," he said. According to the bank governor, a uniform 1 percent rise in JGB yields would result in an evaluation loss of 3.5 trillion yen ($43.6 billion) in major Japanese banks' JGB holdings and 2.8 trillion yen at regional banks. While the risk of distortion exists, the market so far has eased pressure on the BoJ by driving USD/JPY to a level not seen since August of 2011. Japanese Prime Minister Yoshihiko Noda also commended the bank for a positive market reaction. "The market reacted favorably to the BOJ's monetary easing on Feb. 14 and its governor's explanation. The government and the BOJ will continue close cooperation and I expect the BOJ to take timely and decisive monetary policy steps,” said Noda. With no major economic releases, the yen could trade mainly on market sentiment.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be our currency pair in play for the next 24 hours. From Europe, we expect the final German GDP at 2:00AM ET/ 7:00 GMT. The economic releases from the US are final U of Michigan consumer sentiment at 9:55AM ET/ 14:55 GMT, followed by new home sales at 10:00AM ET/ 15:00 GMT.

With the rally today, EUR/USD has traded well into the up-trending zone determined by our double Bollinger Bands. The nearest resistance is at the psychologically significant 1.35 handle, which is at the 38.2% Fibonacci level. The Fibonacci retracement was drawn from the swing high in May 2011 to the record low in January. If the pair climbed higher, the 200-day SMA could provide further resistance at 1.3731. On the flip side, the pair’s decline could be supported by the 23.6% Fibonacci level at 1.3172. A break below, the pair could target 1.3038, the lower second std. dev. Bollinger Band.