Optimism for the EUR Unjustified?

Capital market risk is allowed now that the Spanish get their money to prop up their ailing financial system. They are adamant that it is ‘not’ a rescue, it’s a credit line. If you are Irish, it seems that you got ‘royally stuffed’ twice this past weekend. Once deservedly by Croatia at Euro 2012 and second by the EU imposed austerity measures on their own +EUR85B bailout, now that Spain seems to have garnished preferential treatment. The interest rate that Spain will have to pay on its loan agreement will depend on market conditions and could average between +3 and +4%. The amount that they could end up borrowing may not reach the +EUR100b number being thrown around. Obviously, it will be a number that will influence the country indebtedness. Expect it to be explained to the Irish, that unlike Ireland, only part of the Spanish banking system needs support and that the Spanish have been working very hard to engage in economic reforms before aid was given. Oh, to be so small and even further away from the core!

The question being asked is how much of a relief rally will it be? Is this bailout a game changer? With the current market pricing one gets the feeling that investors are far from convinced. The litmus test will involve the fixed-income ‘boys.’ Are they able to tighten the Spanish/Bund spread significantly and reverse the trend of the last 24-months? This morning 10-year spread is-20bps tighter on the day at +4.66%. Even the cost of protecting Spanish debt against default has also fallen in early trading. Will it be sustainable or reversible, that is all speculators and investors are concerned about.

The current common belief is that even if improved risk conditions can be sustained, and it’s a big if, the common currency has little chance of a sustained recovery and remains both technically and fundamentally a huge sell on rallies. To some, a market close above 1.2670 is needed to suggest that record shorts are beginning to question their positions. The decision to give Spain preferential treatment will only “fuel further resentment within the three countries already in receipt of rescue funds and increase political protests against austerity packages.” The real game changer would most likely require the laying down of a Eurobond framework. There is one rumored to be in the making and obviously against German wishes.

Market rhetoric seems unified against the EUR in the long run this morning. It has been difficult to find a pro-EUR supporter. The market price squeeze is telling you that a relief rally is warranted. It has occurred in Asia, with some help from weekend Chinese data, has occurred in Europe, albeit reluctantly, and the North American session will not want to be left out. The ‘big’ boys will feel that they need to at least put the squeeze on. These Hedge funds want to improve their offside short positions average and there is no better way, when you have the ammo, than to squeeze the weak shorts and make them pay up. The common thought is that optimism for the EUR is unjustified. The outlook for both the region and the currency remain uncertain. Despite the bailout being positive for the Spanish banking system, Spain will end up owing more money and one should now expect the other peripheries to look to renegotiate their terms. None of this improves regional stability!

The relief rally is likely to be short lived given the lack of growth plan or structural reform for Europe. What is the source of this funding? Not untypical of European bureaucracy, there is a lack of detail and too many unanswered questions. Does this “credit line” weaken Spanish authority in future Euro discussions about excess deficits? Has Spain been demoted from the big table? No matter what, common currency focus will be shifting from Spain to Greece with next Sunday’s elections looming. Very few expect a Greek party to win absolute majority. The market should be expecting a coalition to form where renegotiation of their bailout conditions is likely to be high on the post-election agenda, implying extended market uncertainty.

The daily trend studies has the EUR in overbought territory, with a risk for it to trade lower. The market wants to stick with favoring the short side, believing that the current relief rally will provide better opportunities to get short trades away. Can the record weak short withstand one more push higher?

Forex heatmap

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Is the EUR now on Life Support?

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell