Euro Strength Intact as Contagion Ends Aussie Dollar Haven
The euro is confounding bears predicting a meltdown as it gets an unexpected boost from the economic and political turmoil gripping Europe.
The 17-nation currency has risen about 1 percent against nine peers from this year’s low on Jan. 16, while the dollar slid 2.3 percent, data compiled by Bloomberg show. Futures traders are trimming bets that it will fall against the dollar, while options show investors are less bearish.
Europe’s common currency is trading more than 8 percent above the average against the dollar since its 1999 creation even after Spain, Greece, Italy and Portugal slid into recession and Nicolas Sarkozy became the first French president in 30 years to fail to win re-election amid a region-wide backlash against austerity. The turbulence is infecting economies including Australia and Sweden, regarded as havens, prompting policy makers in those countries to cut interest rates, weakening their currencies.
“The euro’s pretty much hanging in there,” Eric Busay, a currency and international fixed-income money manager in Sacramento at California Public Employees’ Retirement System, the largest U.S. public pension, with $235 billion in assets, said in an telephone interview on April 30. “When central banks are cutting rates, as they are in several countries, there is clearly not a great reason to be bullish on those currencies.”
The shared currency’s resilience since the debt crisis started in Greece in October 2009 has defied investors including billionaire George Soros, who said in January that German-driven austerity plans in Europe risk creating “tensions that could destroy the European Union.” Bets made at Intrade.com show a 39.5 percent chance of a country exiting the European Union by Dec. 31, 2013, down from 65 percent in November.
Francois Hollande, 57, defeated Sarkozy, getting about 52 percent against about 48 percent for the incumbent, according to estimates by four pollsters. Hollande has advocated a more aggressive European Central Bank role in spurring growth, a measure opposed by Germany.
Greek voters flocked to anti-bailout parties, throwing doubt on whether the two main parties can form a government strong enough to implement spending cuts to ensure the flow of bailout funds. According to projections based on partially counted ballots on state-run NET TV, Pasok and New Democracy would fall one short of the 151 seats needed to win a majority.
‘Currencies Can Fall’
The euro declined 1.3 percent last week to $1.3084 and was 1.8 percent lower at 104.49 yen. Europe’s common currency has averaged about $1.20 since it was introduced in January 1999, and over the last two years has ranged from $1.1877 in June 2010 to $1.4940 in May 2011.
The shared European currency weakened 0.3 percent to $1.3047 at 11:04 a.m. New York time, after dropping to $1.2955, the lowest level in more than three months.
Strategists say the worst may be over. The median of 48 estimates in a Bloomberg survey is for the euro to trade at $1.30 by year-end. It will buy 106 yen, a separate survey showed.
“In a weakening global environment, countries that can cut rates will do so and their currencies can fall,” Kit Juckes, head of foreign-exchange research at Societe Generale SA in London, said in a telephone interview on May 1. “Europe is an economy with a currency that isn’t expensive, with not much scope or appetite for cuts.”
Traders drove the euro higher on May 3, before it ended little changed, as the ECB kept rates on hold and President Mario Draghi said policy makers didn’t discuss a cut. It depreciated 0.1 percent the past three months based on Bloomberg Correlation-Weighted Indexes, which track 10 developed-market currencies, while Australia’s dollar dropped 4.6 percent, the yen 2.4 percent, Sweden’s krona fell 1.2 percent and New Zealand’s dollar 3.6 percent.
Euro estimates are little changed from current levels even after Spain said last week its gross domestic product contracted 0.3 percent in the first quarter, putting the euro region’s fourth-largest economy into its second recession since 2009.
At least eight European leaders have either resigned or lost elections since the start of the debt crisis as austerity measures contributed to the region’s economic slowdown. Dutch Prime Minister Mark Rutte faces elections in September after his coalition government collapsed last month amid a dispute over spending cuts.
International Monetary Fund Managing Director Christine Lagarde said April 19 in Washington that Europe is the “epicenter” of risks to global growth. The economy of the nations that share the euro will probably contract 0.3 percent in 2012 after expanding by 1.4 percent in 2011, the IMF said April 17. The Washington-based lender predicted world growth would slow to 3.5 percent from 3.9 percent last year.
Europe will remain “a potential source of adverse shocks for some time,” Reserve Bank of Australia Governor Glenn Stevens said on May 1 as policy makers reduced their benchmark by 50 basis points, or 0.50 percentage point, to 3.75 percent. The bigger-than-forecast cut drove the so-called Aussie down as much as 1.35 percent against the euro, the biggest intraday drop since November.
Sweden’s central bank has reduced borrowing costs twice since December, to 1.5 percent from 2 percent, as the economy shrank 1.1 percent in the fourth quarter, exceeding the 0.3 percent contraction in the euro zone. Two out of six Riksbank board members called for a cut to 1 percent at the April meeting, when the main rate was kept unchanged, minutes of the gathering showed on May 2.
There’s a 36 percent chance the Riksbank cuts the main rate at its next meeting on July 4, up from 19 percent on April 26, according to a Credit Suisse Group AG index based on swaps. The odds of Australia’s central bank lowering its rate at its next meeting was 89 percent, the Credit Suisse measure showed.
Support for the euro may wane should the U.S. recovery gather pace, reducing the odds that the Federal Reserve will undertake a third round of stimulus that weakens the dollar.
Manufacturing in the U.S. expanded in April at the fastest pace in 10 months, data from the Institute for Supply Management showed on May 1. Four Fed presidents said the same day that more so-called quantitative easing through bond purchases probably won’t be needed. American employers added 115,000 workers last month, fewer than forecast, while the jobless rate fell to a three-year low of 8.1 percent as people left the workforce, the Labor Department said on May 4.
The euro may also weaken if Europe’s economy slows enough to cause policy makers to cut their refinancing rate.
“The ECB is facing a lot of pressure to ease,” Guillermo Felices, head of European currency strategy at Barclays Plc in London, said in an interview on May 1. “Eventually they will have to ease given the pressures on the economy.”
He sees a decline in the euro to $1.20 in the next year.
The backlash against austerity measures is growing. Spain’s largest unions led marches involving thousands of protesters in 55 cities April 29. Riots have broken out in Greece in response to government cuts in pensions and wages.
Spain’s 10-year bond yield has jumped about 60 basis points this year, or 0.6 percentage point, to 5.73 percent. Italian yields, at 5.43 percent, are 1 percentage point above their average over the past decade. Spain’s IBEX 35 Index of stocks is down 20 percent this year, while the broader Euro Stoxx 50 Index has lost 2.9 percent.
Europe’s common currency is getting support as surveys signal that Germany’s GDP, the region’s largest, will expand for a third consecutive year. That may prompt the ECB to keep borrowing costs unchanged as it seeks to tame inflation that’s been above its target of just below 2 percent since December 2010.
Draghi took over as ECB president in November, and reversed the two rate increases made by his predecessor Jean-Claude Trichet in April and July. He has kept the rate at 1 percent the past five meetings while pumping about 1 trillion euros into the banking system by providing three-year loans in two longer-term refinancing operations, or LTROs, in December and February.
He will keep the rates on hold through at least the third quarter of 2013, based on the median prediction of analysts in Bloomberg News surveys.
The loans “took the risk of a devastating bank failure more or less off the table,” Omer Esiner, chief market analyst in Washington at Commonwealth Foreign Exchange Inc., a currency brokerage, said in a May 3 telephone interview. “While they didn’t necessarily address the underlying issues of the credit crisis, they did kind of ring-fence euro’s banking sector from further deterioration. That was positive overall for the euro.”
The difference in the number of wagers by hedge funds and other large speculators on a decline in the euro against the dollar compared with those on an advance -- so-called net shorts -- was 106,990 contracts on May 1, down from a record 171,347 in January, figures from the Washington-based Commodity Futures Trading Commission show.
The premium for three-month options granting the right to sell the euro against the dollar relative to those allowing for purchases was 2.24 percentage points at the end of last week, down from as much as 2.98 percentage points in February, the 25- delta risk reversal rate show.
“There isn’t really going to be a rate cut in the euro zone,” Christoph Kind, head of asset allocation at Frankfurt- based Frankfurt Trust, which manages about $20 billion, said on May 2. “This makes it at least a little bit attractive against other currencies like the Australian dollar.”
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