Your starter for 10: Why isn’t the euro falling?

It’s a puzzle, what with the whole Greece-possibly-about-to-default-and-maybe-drop-out-of-the-euro thing. We asked some analysts and investors why they think the euro’s exchange rate against the dollar is so steady.

The common currency has been trapped between $1.11 and $1.13 against the dollar since early June. Some signs of stress are coming through in the options space, which we wrote about yesterday. Still, it looks odd.

Katie Martin asked around. Any highlights are ours.

Paul Lambert, Insight Investment:

Why isn’t the euro falling?

Because people are short, realised vol is about to rise and and the outcome is binary so it’s very hard to manage. Net result: people are sitting on their hands. Once we know the outcome on Greece, the euro will move.

Chance of a Greek default: 80%. Of Grexit: 50%

Aurelija Augulyte, Nordea:

Why isn’t the euro falling?

Mostly due to unwinding of euro hedges. As European stocks go down, the euro goes up against the dollar – this relationship has strengthened with the introduction of the ECB QE.

It also reflects positioning – the market is short euros. It has been using it as a funding currency. But also the fact that “this time is different” than 2010: people know Greece has effectively been in default for a while. Backstop plans have been made, there is a cyclical recovery elsewhere in Europe, and the ECB doing massive QE…

The worst case for Greece and the euro area – Grexit with contagion – may actually turn out to be the best case for the euro, due to the positioning to start with, and later due to capital repatriation.

Chance of a Greek default: 65%. Chance of Grexit: 25%

Peter Kinsella, Commerzbank:

It’s stable because Greece is not a material risk for the euro zone. The private sector does not hold Greek debt, so a default and eventual Greek exit from the eurozone will not have second round effects, as say, the Lehman bankruptcy did in 2008.

Every bank and trade partner will by now have either i) curtailed credit exposures to Greek banks and/or corporates ii) made contingency plans for an exit. Then you have the ECB’s OMT and QE policies which should limit any effect on peripheral spreads.

Consequently, it’s not an issue for the FX market, and is unlikely to be. I can see a situation where one month after Greece leaves the eurozone, the euro exchange rates recover to their pre-Grexit levels.

Probability of Grexit: the house view is 50%.

Steve Saywell, BNP Paribas:

The market is short euros as a funding currency. Greek stress reduces risk taking and forces unwinding of these positions. This trend will persist while the market remains short and Greek stress persists. We are focusing on a deal by mid July.

Greek default is now 50% chance but a Grexit is much lower 15-20%.

Shahab Jalinoos, Credit Suisse:

At least for the next month, the market seems clearly in two minds as to whether to treat the euro as a pro- or anti-risk currency. Does it rally if Greek risk is resolved given that European risky assets would do well, or does it perversely go lower as volatility and VaR levels fall and the near-term risk of short covering squeezes dissipates? As long as these questions remain hard to answer, the immediate risk-reward for euro positioning looks unappealing.

The euro area has actually found a way to immunize itself from Greek contagion. Deleveraging by European banks since 2012, combined with a lack of direct private-sector exposure to Greek debt, arguably leaves Europe’s banking system less exposed to Greece than in the past. And the introduction of OMT, TLTROs and now QE by the ECB creates more of a backstop for the periphery than existed before. Direct and persistent liquidity injections via ECB bond purchases also reduce the need to price in “panic” scenarios.

Jane Foley, Rabobank:

Market positioning, risk aversion/risk appetite, the ECB’s QE programme and the Eurozone large current account surplus are likely factors.

The eurozone’s current account surplus stood at EUR18.6 bln in March. While this well below the EUR30.5 bln that was recorded at the start of the year, it is still a generous figure. The current account balance has been trending higher since 2011 and this year’s high marks a record since the inception of EMU. A current account surplus does not on its own establish a safe haven currency but it is a highly desirable quality for a safe haven and does increase the likelihood of associated behaviour – as is currently being exhibited by the euro.

The combination of uncertainties regarding Greece and domestic political uncertainties in countries such as Poland and Turkey threatens to undermine demand of higher risk emerging-market assets and drive money home to current account surplus nations.

Kit Juckes, SG:

1) The market doesn’t really believe in Grexit. 2) the market doesn’t really think the Fed’s going to do anything much. 3) the market doesn’t think Grexit, or Fed hikes, make much difference 4) Euro buying from people cutting back European equity exposure as it drifts down

I think we’ll get a move when we get a September Fed hike properly priced in and a further rise in front-end US rates. Or if Grexit actually happens. I want to be short euros in July/August

There’s a 99% probability of a Greek default some time… A 40% chance of default in this round, and a 40% chance of Grexit this summer.

Simon Derrick, BNY Mellon:

The price action elsewhere (moves in core/periphery spreads, the resurgence of sterling as safe haven trade) says [the stability] might not last that much longer.

If there’s a default and ELA is withdrawn then a move towards Grexit is very possible. A parallel currency could be interim step though.

It seems reasonable to suppose that a default and possible exit by Greece could, in turn, see the ECB take further steps (“whatever it takes”) to dampen the impact on the other nations. In a yield-driven world this could well be the move that really dents the euro.


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