Bloomberg News

Euro Above Average Since Debut Undermines Calls for Collapse

September 26, 2011

(Updates prices in seventh, ninth paragraphs.)

Sept. 26 (Bloomberg) -- For all the concern about sovereign default in Europe, the euro remains above its average since being created almost 12 years ago, a sign that foreign-exchange traders see little chance of a collapse as officials step up efforts to keep the debt crisis from expanding.

“Too much political and ideological capital has been invested into making the euro project work and bringing the continent of Europe closer together since the end of World War II to allow it to unravel now,” Thanos Papasavvas, the head of currency management in London at Investec Asset Management Ltd., which invests about $95 billion, said in a Sept. 20 interview.

Investors from billionaire George Soros, whose $10 billion bet in 1992 preceded the Bank of England’s devaluation of the pound, to John Taylor, who runs the world’s biggest currency hedge fund, have predicted the euro’s breakup or forecast it will slump to parity with the dollar.

At the same time, the currency’s relative strength reflects the commitment of German Chancellor Angela Merkel and French President Nicolas Sarkozy to solve the region’s debt crisis and keep Greece, Ireland and Portugal in the 17-nation bloc. While bonds show growing expectations of a Greek default, currency strategists still predict the euro will appreciate this year.

Rescue-Fund Talks

European governments are exploring accelerating the start of a permanent rescue fund for their economies, with senior finance officials set to examine this week the cost advantages of setting up the European Stability Mechanism, or ESM, a year earlier than its July 2013 start, according to a document prepared for the meetings and obtained by Bloomberg News.

“The euro is still the best way for the peripheral countries in Europe to become more competitive and address their structural issues,” Papasavvas said.

The euro strengthened 1.42 percent last week against a basket of nine developed-nation peers, the most since gaining 1.55 percent in the period ended June 3, according to Bloomberg Correlation-Weighted Currency Indexes. It has risen 1.5 percent from this month’s low on Sept. 12, the indexes show.

At last week’s close of $1.35, the currency is 12 percent stronger than its average of $1.2024 since January 1999. While strategists have cut their forecasts for appreciation, they still see it rising to $1.43 by the end of 2012, based on the median of 35 estimates in a Bloomberg survey.

The shared currency depreciated today, falling to as low as 101.94 yen, the weakest since June 2001, and losing 0.2 percent to $1.3468 at 12:47 p.m. in New York.

‘Cathartic’ Default

Schneider Foreign Exchange, the most-accurate currency forecaster during the six quarters through June 30 according to data compiled by Bloomberg, predicts the euro will trade at $1.56 next year. A default by Greece will prove “cathartic” for the region, shifting attention back to the U.S.’s $1 trillion budget deficit and rising debt, according to Stephen Gallo, the firm’s head of market analysis in London.

Nomura Holdings Inc. cut its year-end prediction this month to $1.30 from $1.40 amid increasing stress in Europe’s fixed- income markets and as investors wait for EU officials to present details on how they plan to keep the union together.

“The big euro-zone bond markets are under pressure and we don’t really have any policy response lined up whatsoever, in fact we’re in a policy vacuum,” Jens Nordvig, global head of Group of 10 foreign exchange strategy in New York at Nomura, said in a Sept. 22 telephone interview.

Default Swaps

The Markit iTraxx Financial Index of credit-default swaps on the senior debt of European 25 banks and insurers jumped as much as 23 basis points on Sept. 23 to an all-time high of 325 basis points, according to JPMorgan Chase & Co. The Markit iTraxx SovX Western Europe Index of swaps on 15 governments rose 5.5 to 365.5, CMA prices show.

Greek two-year note yields posted their biggest weekly increase in the period ended Sept. 23 since it joined the euro region, surging 14.76 percentage points to 69.8 percent, as credit-default swaps signaled a 94 percent probability the government will renege on its obligations within five years. Portugal 10-year yields jumped 63 basis points to 11.8 percent.

Greece and Portugal may be able to regain their economic competitiveness by leaving the euro, Soros said in a Sept. 16 New York Times editorial. Taylor, whose FX Concepts LLC oversees $8.5 billion, has said the euro would fall to parity with its U.S. counterpart as the EU crisis escalates.

Austerity measures in Europe designed to lower debts and deficits means the EU’s economy may grow more slowly.

IMF Cuts Outlook

The International Monetary Fund cut its estimates last week for the region’s expansion this year to 1.6 percent from 2 percent, and in 2012 to 1.1 percent from 1.7 percent. That compares with growth of 4 percent in 2011 and 2012 in the world economy, the organization forecast.

“Damage is done,” JPMorgan Chase & Co. Chief Economist Bruce Kasman said Sept. 24 during a panel discussion at the Institute of International Finance annual meeting in Washington. “Europe in our mind is entering recession. Greece is insolvent and the European Union needs to deal with that. It hasn’t yet come to terms with that.”

The ESM will have a 500 billion-euro ($670 billion) war chest that would help shield countries such as Italy and Spain from the region’s growing debt crisis. It also includes provisions for sharing costs with bondholders for countries with “unsustainable” debt.

Credit-default swaps on sovereign debt of Italy, Spain, Belgium, France and Germany also rose to records on Sept. 23. Contracts on Italy rose 13 to 547, Spain jumped 17 to 450, Belgium climbed 10 basis points to 304, France increased 3.5 to 206, Germany advanced four to 110, CMA prices show.

‘Effective Financing Structure’

Faster ESM enactment would provide a “more effective financing structure” that cuts the extra debt of donor countries by 38.5 billion euros, according to the document obtained by Bloomberg News. “This gain is to be considered as a minimum,” it said.

Asked by Bloomberg Television about bringing forward the ESM’s start date, EU Economic and Monetary Affairs Commissioner Olli Rehn said the focus for now is on upgrading the temporary fund, the 440 billion-euro European Financial Stability Facility.

Speculating on a weaker euro means betting against the ability of Merkel and Sarkozy to keep the EU together. The two said this month in a joint statement that “it is more than ever indispensable” to “assure the stability of the euro zone.”

IMF Managing Director Christine Lagarde said investors haven’t taken into account “very solid fiscal consolidation” in some euro region nations.

‘Under the Skin’

“I would hope that analysts would actually look under the skin of budgets of economies, of policies, to appreciate their solidity,” Lagarde said in a Sept. 22 Bloomberg Television interview with Tom Keene.

Germany, Europe’s largest economy, benefits from keeping the EU together because 43 percent of its goods, or about 416 billion euros, are sold within the region. Exports were 4.9 percent higher last quarter than three years ago.

“It would complicate trade a lot if the euro zone breaks up, never mind the socio-economic impact,” Ulrich Leuchtmann, Commerzbank AG’s head of currency strategy, said in a Sept. 22 telephone interview from Frankfurt. “The euro is the main tool for stronger European integration.”

The euro is the second-most traded currency after the dollar, according to the Bank for International Settlements in Basel, Switzerland. It accounted for 26.6 percent of global currency reserves as of March 31, up from 18 percent at its inception, and second only to the greenback’s 60.7 percent.

Euro Support

Concern the U.S.’s debt and deficits may become unmanageable as economic growth slows is helping support the euro. The Federal Reserve said last week it would sell $400 billion of short-term debt and reinvest the proceeds in longer- maturity Treasuries to contain borrowing costs because of what it sees as “significant downside risks to the economic outlook.”

“There’s still enough concern about the Fed and the U.S. economy that it limits the degree to which the euro falls,” Steven Englander, head of Group of 10 currency strategy at Citigroup Inc. in New York, said in a Sept. 21 telephone interview.

Over the life of the euro, the Bloomberg Correlation- Weighted Index that measures its performance has ranged from as low as 89.3740 in October 2000 to as high as 120.3054 in December 2008, before ending last week at 99.4761.

Euro Challenges

Against the dollar, it has ranged from 82.3 cents in October 2000 to $1.6038 in July 2008. The euro will hold above $1.30 this year as central banks led by the Swiss National Bank and sovereign-wealth funds such as those in Asia seek alternatives to the dollar, Michael Derks, the chief strategist at foreign-exchange broker FxPro Group Ltd. in London, said last week.

“I don’t think the euro is going to break up, it’s facing lots of challenges but it’s not going to fall apart,” Audrey Childe-Freeman, global head of currency strategy in London at the private-banking unit of JPMorgan, said Sept. 22 by telephone. “Economically, no member country would gain from a breakup of the euro-zone and that’s why politically, it’s unlikely to happen.”

--With assistance from James G. Neuger in Brussels, Aki Ito in Washington and Dawn Kopecki in New York. Editors: Philip Revzin, Robert Burgess

To contact the reporters on this story: Catarina Saraiva in New York at asaraiva5@bloomberg.net; Garth Theunissen in London gtheunissen@bloomberg.net.

To contact the editors responsible for this story: Daniel Tilles at dtilles@bloomberg.net; Dave Liedtka at dliedtka@bloomberg.net


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