Greece proving to be sideshow for German-powered euro
The chance of a Greek exit from the euro is on the rise, and so the question for investors has turned from why is the single currency so strong, to how low can it trade and how fast.
Greece has taken the blame for the latest lurch lower in the single currency, with the failure of Athens to form a government raising the prospect that Greece could withdraw from the euro. That might be premature. A weekend foray by EuromoneyFXNews to Thessalonika revealed that the locals were abandoning the main parties in protest over perceived corruption, which has left the country''s coffers bare despite all the transfers from Brussels, and not any desire to leave the single currency.
Nevertheless, the consensus opinion has changed since the vote and states that a Greek exit is likely during the next six to 12 months. For example, 70% of the audience at last week''s Euromoney FX conference thought Athens would leave the euro within a year.
Indeed, there are many that think Greece would be better off leaving the euro, given that it faces years of austerity if it chooses to stay in the single-currency club.
As Simon Derrick, head of currency strategy at Bank of New York Mellon, points out, it would be better for Greece to suffer the brutal pain of an exit and at least have the chance of a recovery in several years'' time than to live with the certainty of a slow, relentless decline in its economy with no chance of a reprieve.
"If it is a choice for Athens between staying within the eurozone under its current configuration or reintroducing the drachma, then they should choose the latter," he says.
Euro resilient as "Grexit" talk mounts
Heightened speculation of a "Grexit" has, of course, has spilled over into other peripheral eurozone markets, with fears of contagion, and particularly Spain''s ability to weather the storm, once more prompting jitters on global asset markets.
However, EURUSD has reacted with a steady grind lower, albeit breaking out of the tight three-big-figure range above $1.30 that held since the start of April, rather than the rout that saw it plummet from $1.50 to $1.40 when Greece announced it would need another bailout this time last year.
The relatively muted reaction in EURUSD perhaps reflects the view that a Greek exit, if it occurs at all, is likely to increase turbulence in the near term but could be absorbed by the country''s eurozone partners without endangering the future of the euro.
The single currency, after two long-term refinancing operations from the European Central Bank relieved pressure on the region''s banks, is simply a more viable proposition than it was a year ago.
The muted drop in EURUSD also reflects positioning in the single currency.
Mansoor Mohi-uddin, global head of FX strategy at UBS, says while a Greek exit is now an option, he suspects EU officials would rather not be tested on assertions that the currency union is well placed to withstand such an event.
"Nonetheless, the market remains structurally short of the euro, and the marginal impact of any good news could yield a disproportionately positive reaction in price action, so we remain cautious in pushing for any acceleration in the pace of euro downside for now," he says.
Net currency position vs USD (million) of speculators on CME, May 8, 2012
|Source: CFTC, Data Insight, Scotia FX Strategy|
In other words, Mohi-uddin expects that steady grind lower in EURUSD to continue rather than a sharp sell-off, given the market is positioned that way already. The truth is, of course, that nobody really knows the impact a Greek exit could have on the single currency. Our inbox at EuromoneyFXNews has been overflowing with reasoned analysis on the repercussions of such a move.
The most striking thing is, however, that, unlike at the start of the eurozone debt crisis, few are calling for a plunge in EURUSD towards parity.
Jens Nordvig, head of global currency strategy at Nomura and shortlisted for the £250,000 Wolfson prize for the best suggestion for how to handle the break-up of the euro, believes the right target for EURUSD in the event of a Greek exit is in the $1.15 to $1.20 range, for example.
"The basic premise behind our view is that a Greek exit would lead to further instability in the eurozone banking system, a further rise in risk premia on eurozone assets and additional deterioration in external capital flows," he says.
Germany the driving force
However, not all believe that a euro without Greece would ultimately be a weaker currency.
They point to the resilience of the German economy, which, according to figures released on Tuesday, grew five times more than forecast in the first quarter and appears single-handedly to be propping up the eurozone economy.
Jane Foley, senior currency strategist at Rabobank, says that Germany continues to have a good crisis, with unemployment at historically low levels. Undoubtedly, along with labour-market reforms, that is partly down to Germany''s exchange-rate position, she says.
Indeed, Germany''s real effective exchange rate had surged in the years between Germany re-unification and the start of the Economic and Monetary Union (EMU), but is now holding at much more accommodative levels.
The Organization for Economic Co-operation and Development estimates that the euro is just 2.3% overvalued, while in contrast the Swiss franc is estimated to be 37.4% overvalued.
Clearly then, Germany''s exporters, its labour market and broader economy have benefited from the country''s association with the weaker countries within EMU. That German economic power, in turn, has contributed to the euro''s resilience to the current turmoil.
As Foley says, the euro faces weeks and potentially months of uncertainties as to what the outcome for EMU will be, during which EURUSD will be open to downside pressure.
"However, a 16-member EMU would eventually be positive for the euro," she says. "If the euro were to eventually belong to Germany and the core, it would be an even stronger currency."
Weather the storm and a Greek exit from the euro might not be such a disaster for the single currency.