Bloomberg News

Euro Strategists Draw Line at $1.34 as Merkel Seeks Rescue

November 02, 2011

(Updates prices in starting in fifth paragraph.)

Oct. 24 (Bloomberg) -- Foreign-exchange strategists have ceased cutting forecasts for the euro as European government officials intensify efforts to end the region’s crisis and traders pare bets for a collapse in the currency.

Between Sept. 12 and Oct. 6 the median year-end estimate of more than 40 analysts surveyed by Bloomberg tumbled to $1.35 from $1.43. It has ranged between $1.34 and $1.35 since then. The 17-nation currency, which closed at $1.3896 on Oct. 21, has strengthened 2.5 percent from last month’s low on Sept. 12 against a basket of developed-nation peers measured by Bloomberg Correlation-Weighted Indexes.

For all the concern that European officials led by German Chancellor Angela Merkel and French President Nicolas Sarkozy may not be able to fix the region’s sovereign debt crisis, the $4 trillion-a-day currency market is signaling that the worst may be over for the euro. Leaders meeting yesterday outlined plans to aid banks and ruled out tapping the European Central Bank’s balance sheet to boost its rescue fund.

“There’s a clear sign of commitment by policy makers to support the euro project and as such the euro is not going to be allowed to collapse,” Dale Thomas, head of currency management at Insight Investment Management Ltd. in London, which has about $220 billion in assets under management, said in a telephone interview Oct. 21. “It’s quite possible that we will get some more near-term euro strength.”

Less Bearish

Options traders are becoming less bearish on the euro. They are paying 3.37 percentage points more for the right to sell the common currency against the dollar than they are to buy it. The so-called one-month 25-delta risk reversal rate has narrowed from a closing-price record 4.03 on Sept. 6.

“For now the market really wants to believe in a solution and there’s an unwinding of the previous pessimism” toward the euro, John Hardy, head of foreign-exchange strategy at Saxo Bank A/S in London, said in a telephone interview on Oct. 19.

The euro will end the year at $1.30; the “risk” is that it may end stronger “if the market finds more confidence in Europe,” Hardy said. Current talks are “designed to be an impressive show of force to restore confidence,” he said.

The euro rose 0.4 percent to $1.3944 at 2:01 p.m. New York time, or 16 percent stronger than its average of $1.2032 since January 1999 and up from this year’s low of $1.2867 in January. It was little changed at 106.05 yen. That compares with an average of 128.67.

Bearish Bets

Traders are already trimming bearish bets that would profit from a weakening currency, and anything less than a collapse in the talks may cause them to reduce those positions further.

The difference in the number of wagers by hedge funds and other large speculators on a drop in the euro compared with those on an advance was 77,720 on Oct. 18, compared with so-called net shorts of 82,697 in the period ended Oct. 4, which was the most since June 2010, according to data from the Commodity Futures Trading Commission in Washington.

“A plan takes some of the uncertainty away and that is positive for the euro,” Pierre Lequeux, head of currency management in London at Aviva Investors, which manages about $410 billion, said in a telephone interview on Oct. 21. “I am a bull because I think that the market has been very anti-Europe over the last year.”

Europe’s 13th crisis-management summit in 21 months excluded a forced restructuring of Greece’s debt, sticking with the policy of enticing bondholders to accept “voluntary” losses to help restore the country’s finances. The complete blueprint won’t come together until the next summit on Oct. 26.

German Aim

Bank capital needs will be met first by banks themselves, then by national governments, the European officials agreed. Only when these efforts fail can governments tap the main rescue fund, the 440 billion-euro European Financial Stability Facility, for cash to channel to banks. Germany pushed through one of its main summit aims, defeating French efforts to bulk up the rescue fund by enabling it to borrow potentially limitless sums from the ECB.

The currency is forecast to weaken 4 percent by year-end versus the 16 pairs for which Bloomberg tracks estimates, as concern persists over the inability of policy makers to narrow differences on the role of the bailout fund, recapitalization of banks and restructuring of Greek debt. That is up from 3 percent forecast in August.

The ECB cut its growth forecasts for 2011 in September to 1.6 percent from 1.9 percent, and to 1.3 percent from 1.7 percent for 2012. It publishes its next set of estimates on Dec. 8, and may say the region will expand at half the rate of the U.S. next year, according to a Bloomberg survey.

‘Fiscal Discipline’

Incoming ECB President Mario Draghi said during a speech in Frankfurt Oct. 19 that there can be no economic growth or financial stability in Europe without “fiscal discipline.”

“It is going to be extremely difficult to avoid recession in the euro region unless European leaders come up with a plan to boost growth as well as end the turmoil,” Eric Le Coz, deputy managing director at Carmignac Gestion, who oversees about 50 billion euros, said in a Oct. 21 interview. “We are underweight the euro. It should weaken.”

The euro is the second-most traded currency after the dollar, according to the Bank for International Settlements in Basel, Switzerland. It accounted for 26.7 percent of global currency reserves as of June 30, up from about 18 percent at its inception, and second only to the greenback’s 60.2 percent, data from the International Monetary Fund show.

Capital Requirements

Banks in France, the U.K., Ireland, Germany and Spain have announced plans to shrink by about 775 billion euros in the next two years to reduce short-term funding needs and comply with tougher regulatory capital requirements, according to data compiled by Bloomberg. Morgan Stanley analysts predict the amount could reach 2 trillion euros across Europe by the end of next year as banks curb lending, and sell loans and businesses.

Efforts by financial institutions to shrink may support the euro in the near term, according to John Taylor, founder and chairman of New York-based FX Concepts LLC, the world’s largest currency hedge fund.

“You’re selling subsidiaries, your bank’s non-core assets,” Taylor said in an interview in London on Oct. 19. “If they sell those assets to an American, or a Brit, somebody’s got to buy euros to do that.”

Rating Risk

Credit-default swaps show traders see a more than 90 percent chance Greece will default, and yields on 10-year bonds in France, which Moody’s Investors Service and Standard & Poor’s say is at risk of losing its top credit rating, have risen to more than 1 percentage point above similar-maturity German bunds. Even so, none of the more than 40 strategists surveyed by Bloomberg see the euro falling below the $1.1877 level it traded at in June 2010. That was its weakest since 2006.

“The fact that the euro has rallied to around $1.38 shows that there’s an expectation that the leaders are going to come up with something,” Jeremy Hale, head of macro strategy at Citigroup Inc. in London, said in a telephone interview on Oct. 21. “We’ll have to see how close we get to something that looks like a credible package.”

The forecasts are for the euro to trade at $1.39 by the end of June and $1.40 at year-end 2012.

Two increases in the ECB’s main interest rate this year to 1.5 percent have supported the shared currency, while the Federal Reserve and the Bank of England held benchmark borrowing costs at record lows.

Interest Rates

Fed Chairman Ben S. Bernanke and his colleagues on the Federal Open Market Committee pledged in August to hold rates near zero until mid-2013. The Bank of England held its benchmark at 0.5 percent on Oct. 6, and expanded its bond buying program.

The ECB resisted calls to cut rates at its meeting on Oct. 6, opting instead to resume covered-bond purchases and yearlong loans to banks. Euribor futures fell, pushing the implied yield on the contract expiring in December up by more than 10 basis points to 1.35 percent as traders pared expectations for lower rates. A basis point is 0.01 percentage point.

“The recession in Europe I think is going to happen, and if the ECB does what it should and aggressively eases policy, there should be a weaker euro” next year, Insight Investment Management’s Thomas said. “On the other hand, it is a world where all the other central banks are easing policy already and if the ECB drags its feet, then the euro will stay relatively strong.”

--With assistance from Paul Dobson in London, James G. Neuger and Tony Czuczka in Brussels and Garfield Reynolds in Sydney. Editors: Daniel Tilles, Dave Liedtka, Dennis Fitzgerald

To contact the reporters on this story: Emma Charlton in London at echarlton1@bloomberg.net; Allison Bennett in New York at abennett23@bloomberg.net.

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


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