Investors trim bets against EUR; downside risk remains for single currency

The latest Commitment of Traders report, issued by the Commodity Futures Trading Commission, showed investors pared their short positions by 7% in the week to June 12, reducing the value of the net short position in the single currency on the exchange to $30.5 billion.

That still meant short-term speculators held close to record net short EUR positions, but would have taken some of the edge of the short-covering rally that met news on Sunday that Greece’s pro-bailout New Democracy party had won the largest share of the vote in the poll.

The news, which reduces the chances of a Greek exit from the eurozone, gave the financial markets the result it would have hoped for: the prospect of a pro-euro, pro-bailout coalition with a workable majority.

While EURUSD initially rose to a one-month high of $1.2750, the relief rally quickly ran out of steam, with EURUSD losing more than a cent to $1.2640, as the realities of the dire situation in Athens resurfaced.

“A temporary relief rally in the EUR and risk assets does not mean that uncertainty has been eliminated, either immediately or in the medium term,” says David Bloom, head of FX strategy at HSBC.

Antonis Samaras, New Democracy leader, has a tight deadline to updated Greece’s medium-term financial strategy and identify cuts amounting to €11 billion (5.5 % of GDP) by the end of June to close the fiscal gap by 2014.

Once those have been approved by the troika of the International Monetary Fund, European Central Bank and EU, then Greece will receive the planned €31 billion of troika funding, including €23 billion for bank recapitalizations.

Assuming that hurdle is crossed, says Bloom, the fact remains the challenges facing Greece are still substantial, and with the economy still mired in recession and the debt stock still very high, solvency concerns will persist.

“Hence this election outcome is unlikely to put the prospect of euro exit for Greece on the backburner for long,” he says. “All these uncertainties will likely limit the pace at which the EUR can rally, and may also constrain the upside on risk assets.”

In any case, while the Greek situation did not descend into the chaos some had feared, it is by no means the only source of fear within the eurozone.

Mansoor Mohi-uddin, head of FX strategy at UBS, says investors should be wary of a market-friendly Greek vote and sell any rally in EURUSD up towards $1.30.

He points to concerns about the finances of Italy and Spain, whose 10-year bonds have breached key levels above 6%.

Indeed, Spanish bond yields rose to a euro-era high of 7.13% on Monday, after figures from the Bank of Spain revealed bad loans rose to 8.72% of the total in April, up from 8.37% in March.

The increasing growth rate of bad loans in Spain will lead to questions about the degree of recapitalization the banking sector needs during the next two years.

That could render the €100 billion buffer made available to the Spanish banking sector last week insufficient, and increase fears that Madrid will have to ask for a fully fledged bailout.

So, disaster averted in Athens, but the risks for the euro remain large.