Oct. 28 (Bloomberg) -- The surge in the euro after policy makers agreed to a plan to boost the region’s rescue fund may prove short lived as economic fundamentals don’t support an appreciation of the common currency, according to Citigroup Inc.
The 17-nation euro rallied the most in more than a year against the dollar yesterday after European leaders agreed to expand a rescue fund for indebted nations to 1 trillion euros ($1.4 trillion) and reached an accord with lenders for a 50 percent Greek-debt writedown.
A strengthening euro “is not corroborated by the fairly muted correction in fundamental drivers like sovereign debt risk,” Valentin Marinov and Steven Englander, currency strategists at Citigroup in New York, wrote in a note distributed today. “Measures of relative rate expectations, like the two-year German-U.S. bond yield spreads actually tightened in the last few days.’
The euro appreciated as much as 2.5 percent to $1.4247 yesterday, the highest since Sept. 6. The common currency fell 0.2 percent to $1.4162 at 12:02 p.m. New York. A Citigroup model for accessing fair value indicates that the euro should trade at $1.385.
“The post-summit euro rally is driven by a continuing squeeze in short risk positions and unwinding of worst fears of financial contagion,” wrote Marinov and Englander, who didn’t comment beyond the report when contacted today. A short is a bet that a asset or security will decline in price.
Wagers by hedge funds and other large speculators on a drop in the euro declined to 77,720 in the week ended Oct. 18, from so-called net shorts of 82,697 on Oct. 11, statistics from the Washington-based Commodity Futures Trading Commission show. Figures of the most current week, that ended Oct. 25, will be released today.
The gap of German two-year note yields, at 0.60 percent today, above those on similar maturity U.S. Treasuries is 31 basis points, down from a 39 basis points spread at the end of last week.
Italy’s borrowing costs rose to a euro-era record at a sale of three-year bonds today, driving yields higher on concern that efforts to contain the sovereign crisis won’t be enough to safeguard the region’s third-largest economy. Italy sold 3.08 billion euros of 2014 bonds to yield 4.93 percent, the highest since November 2000.
“If peripheral euro zone rates do not come down, growth will disappoint and pressures will re-emerge quicker than expected,” Marinov and Englander said. ‘As long as investors are not convinced enough of the reduction in peripheral risk to bring the risk premium down, the downward spiral of poor economic performance and missed fiscal and debt targets is likely to continue.”
The euro’s gains will likely be sustained through next week as global policy makers meet, according to Citigroup. The Federal Reserve and the European Central Bank will hold regular rate setting meetings next week, while French President Nicolas Sarkozy will host a Group-of-20 summit.
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