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BY PERSELLA IOANNIDES
When the Greek debt crisis first erupted in April 2010 the EURUSD declined from 1.35 reaching 1.19 in June 2010. Various investment gurus expressed pessimistic views, even betting on the EUR to fall to parity with the USD as at its birth in May 1998. With the May 2010 bailout of 110 bln euros from the Eurozone countries and the IMF, the Euro debt crisis had initially quelled. Moreover, the US Fed launched QE2 in November 2010 to spur growth and maintain US economic recovery. These two main variables boosted the EURUSD to near all-time highs of 1.50, perceived by general consensus as an overpriced level.
In May 2011, the Euro debt crisis took its toll with the worsening situation in Greece rippling the much feared contagion effects to the rest of the peripheral countries of the Eurozone. The EURUSD had held up surprisingly well and closed the year at 1.29. This may be attributable to a repatriation of the EUR via a sell-off of assets by European banks struggling to meet the new Core Tier 1 ratio requirement of 9% set by the European Banking Authority.
In our current unprecedented economic times, it is hard to attempt to predict the trend of the EUR. We can, nonetheless, analyse a few domineering fundamentals that have predicted its historic trend.
Primarily, it is in the interest of countries to have weaker currencies as it increases their trading competitiveness in times when the developed world is struggling for growth. Several central banks have applied currency interventions to this effect including Switzerland’s and Japan’s. Concurrently, the UK’s QE programmes have also pressured the GBPEUR. Both factors account for an influential play in trend.
Moreover, amongst increasing market and, effectively, currency volatility global central banks endeavor to divert respective reserves out of the USD, the world’s reserve currency, into other currencies such as the EUR and the Canadian and Australian dollars. Following the recent EUR weakness there may be a reluctance to increase respective stakes, although statistics illustrate that EUR to USD proportions have not altered greatly. It will probably prove prudent to further diversify as economic dynamics are constantly changing. Alternatively, a shift of view on diversification or on the EUR will have a material impact as it currently forms 25% of global central bank reserves.
Additionally, the so-called carry trade, where traders borrow low-yielding currencies and long higher-yielding currencies or assets, also forms a major role. With the ECB’s predominant focus on inflation in its monetary policy operations, former president Trichet kept a persistent view of not easing interest rates in line with above-target inflation levels, irrespective of meager growth. Draghi, the ECB’s new president, performed two rate cuts last autumn to 1%, modestly higher than the US fed fund rate of 0.25%. Inclination to perform carry trades on the EUR should now increase and put downward pressure on the currency. In this credit crisis, however, the ECB rate spread versus the Fed Fund or BOJ rate may still lure the borrowing of USD or JPY vs. the EUR. Furthermore, the previous trend of risk taking and the USD has shifted now with the USD weakening in line with risk and vice versa indicating borrowing in the USD (rather than the EUR) and investing in foreign assets and currencies.
Finally, the Greek debt crisis still lingers. There remains an ongoing debate on the appropriate dealing of the hit of the Private Sector Involvement (PSI) bond holders that stands in the way of Greece securing the 130 bln euro bailout loan in March. With the aid of the ECB, peripheral government debt buying and the 3-year loan programme it made available to banks, investor confidence has somewhat resumed in the Eurozone with increasingly successful debt auctions of troubled Eurozone countries such as Italy and Spain locking in lower respective 10-year debt yields (6.12% and 5.4%, respectively).
We have seen that the convoluted Greek problem never ceases to negatively surprise us, however, and like the global central banks, we too should remain diversified in our currency holdings.
Persella Ioannides is a Director at Meritkapital Ltd, a CySEC licensed investment firm rendering brokerage (DMA), investment advice, asset management and custody services. www.meritkapital.com
