The European debt crisis is once again hitting the headlines and the probability of a Greek exit from the eurozone has risen. Harvinder Kalirai, chief strategist at BCA, argues, however, that a Greek exit will not necessarily lead to European Armageddon and a free-fall in EURUSD.
“Since Greece is the weakest link in the currency union, its removal could actually leave a strong euro in its wake,” he says.
| Short euro positioning likely to contain EURUSD fall |
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| Source: BCA Research |
“Of course, the spread of contagion to Portugal, Ireland or the European banking system represents the biggest risk. But for now, it is encouraging that Portuguese and Irish CDS and bond spreads have not widened.”
Kalirai says while the euro area needs a weaker currency, so does the US.
He notes a worsening US trade deficit is a warning that the dollar needs to weaken to reduce its drag on the economy.
Meanwhile, steady demand for euros from global central banks provides some support for the common currency. In addition, speculators are already aggressively short the euro, so the lack of latent selling pressure could also limit the downside for EURUSD.
Kalirai acknowledges the European debt crisis could put further downward pressure on the euro.
“However, reflationary policies in the U.S., steady euro demand from reserve managers and an overhang of short euro positions among traders will stem any downside,” he says.