Risk sentiment improved as the plan was announced. Traders reported strong Asian central bank euro buying, as reserve mangers recycled dollars into euros. Other eurozone peripheral spreads tightened, with Spanish and Italian government bond yields down by around 15 basis points.
The euro rose more than two cents against the US dollar during today’s Asia session, as eurozone leaders agreed a bailout package. The euro traded above $1.442 overnight, while the euro rallied against the Swiss franc to a high of almost 1.19 in London.
The Eurogroup has agreed a Greek bailout package of €109 billion, with the interest rate on European Financial Stability Facility loans cut 100 basis points to 3.5%. Private bondholders have been called on to contribute up to €37 billion to the bailout. There could be another €12.6 billion reduction in Greece’s debt burden if bondholders agree to sell their holdings below par as part of a buy-back programme, Citi analysts say.
The rally might have been stronger, Citi says in a strategy note, save for a weaker-than-expected print from German purchasing managers yesterday (July 21). The German manufacturing purchasing managers’ index has dropped to 52.1, down from 54.6 in June.
The rescue plan should be sufficient to bolster the euro over the coming weeks, says Adam Cole, global head of FX strategy at RBC Capital Markets. But the relief rally is likely to be temporary, he warns, as fiscal problems in other eurozone economies continue to weigh on sentiment.
“I’m not sure it ringfences things for longer than two months. In terms of contagion, it should be enough to buy some time,” Cole says. “I don't think we’ll see the same blowout in Italian and Spanish spreads that we've seen over the past couple of weeks. In that sense, it’s an improvement.”
Problems could quickly emerge two months on from the announcement of the package, however, Cole says. The altered terms of the EFSF may have to be ratified by every eurozone member state, he says. “At best, that will create a lot of short-term noise.”
Greece fulfilling its side of the bargain is also far from certain, he argues, adding that it is possible to see some of the country’s privatisation programme running into trouble early on. In the short term, the euro is carrying a risk premium, Cole adds, trading 25¢ lower than it would in the absence of peripheral debt risk. RBC maintains a six- to 12-month euro forecast of $1.30.
Meanwhile, persistent uncertainty over the US fiscal picture is also contributing to euro support, Deutsche Bank strategist George Saravelos told EuromoneyFXNews this week, with the pair trapped in an ugly contest over their respective fiscal woes.
Euro trading is likely to remain range-bound over the coming months, he argues, in the absence of any convincing narrative on either side of the Atlantic. “There’s very little trend to trade on,” he concludes. “I think we've seen euro/dollar touch its highs and low for the year.”