The euro has weathered the worst financial crisis since the Great Depression, bailouts of Greece, Ireland and Portugal, and falling interest rates. Now, investors are betting like never before that a Greek exit would be too much to keep the 17-nation currency above its long-term average.
Hedge funds and other large speculators, which pared trades that would profit from a drop in the euro to the lowest levels since November, rebuilt them to a record high last week, figures released May 18 by the Washington-based Commodity Futures Trading Commission showed. The premium for options that grant the right to sell the euro has more than doubled since March.
Through most of the financial and political turmoil in Europe, the euro held above the average since its January 1999 start as investors put their faith in German Chancellor Angela Merkel to keep the monetary union in place. While they currently forecast little change in the euro versus the dollar, a majority of the world’s biggest foreign-exchange trading firms surveyed by Bloomberg News say the loss of even a weak member such as Greece would risk more departures and send the currency lower.
“Financial markets’ great fear is that if one country left, it would not necessarily be the last,” Alan Ruskin, the head of Group of 10 foreign-exchange strategy in New York at Deutsche Bank AG, the largest currency dealer as ranked by Euromoney Institutional Investor Plc, said in a May 14 telephone interview. “Removing one country, however weak, would not be a route to a stronger common currency.”
The average year-end estimate for the euro among the biggest trading firms is $1.28, ranging from as low as $1.15 at UBS AG to as high as $1.44 at HSBC Holdings Plc. Deutsche Bank forecasts a drop to $1.25 next month before rising to $1.30 by the end of December.
The euro is down from this year’s high of $1.3487 on Feb. 24, and has depreciated about 1 percent since March against a basket of nine developed-market peers. It slipped 0.1 percent to $1.2765 as of 4:22 p.m. London time after weakening 1.1 percent in the five days ended May 18 to $1.2780 as post-election attempts to form a ruling coalition in Greece broke down.
“Having the history of an exit would make the market think it can happen again,” Greg Anderson, the North American head of Group-of-10 currency strategy at New York-based Citigroup Inc., the second-largest dealer, said in a May 14 telephone interview. “That would lead to endemic weakness.”
Citigroup forecasts the euro will end the year at $1.25.
Over the past five years the euro has ranged from as high as $1.6038 in July 2008 to as low as $1.1877 in June 2010. Even with the recent declines, it’s above the average of about $1.21 since the start of 1999.
For much of the past five years, speculating on a weaker euro meant betting against the ability of Merkel and then-French President Nicolas Sarkozy to keep the currency union together. They said in a September statement that “it is more than ever indispensable” to “assure the stability of the euro zone.”
Sarkozy since became the first French president in 30 years to not win re-election. Merkel’s Christian Democratic Union had its worst-ever result in an election this month in Germany’s most populous state.
In Greece, post-election attempts to form a ruling coalition broke down last week, sending Greeks back to the polls next month with surveys giving the lead to an anti-bailout party that would tear up the conditions attached to 240 billion euros ($307 billion) of aid.
A spokesman for Greece’s caretaker government, Dimitris Tsiodras, said Merkel suggested in a May 18 conversation with President Karolos Papoulias that the nation hold a referendum on whether it wants to remain in the euro. Merkel’s office later said reports she called for such a move were untrue.
“If Greece, and this is the will of the great majority, wants to stay in the euro, then they have to accept the conditions” of its bailout, German Finance Minister Wolfgang Schaeuble told reporters after a meeting of European Union finance ministers in Brussels May 15. “Otherwise it isn’t possible.”
A day later, the European Central Bank said it would temporarily stop lending to some Greek banks. ECB president Mario Draghi said while the bank’s “strong preference” is that Greece stays in the euro area, it wouldn’t support the nation at the expense of “the integrity of our balance sheet.”
Record Net Shorts
“It may be a bit of brinkmanship that we are seeing these kinds of comments” Ian Stannard, Morgan Stanley’s head of Europe currency strategy, said in a May 15 telephone interview. “We are still in a situation where things are going to struggle on and there’s going to be high levels of uncertainty, so that suggests the euro will remain under pressure.”
Stannard, who is based in London, sees the euro trading at $1.19 by year-end.
The difference in the number of wagers by hedge funds and other large speculators on a drop in the euro against the dollar versus those on an advance -- so-called net shorts -- rose to 173,869 contracts on May 15 from 79,480 in April and exceeding the previous high of 171,347 in January, CFTC figures show.
In addition, so-called leveraged funds have a dollar equivalent $19.5 billion net short, Citigroup’s Anderson wrote in a report after the figures were released. A leveraged fund may be a mutual fund that borrows money to increase the number of securities it can buy so it can increase its returns.
Premiums for three-month options granting the right to sell the euro against the dollar relative to those allowing for purchases was 3.34 percentage points at the end of last week, the most since December and up from a low this year of 1.41 percentage points on March 21.
The most probable outcome is that the euro will evolve into a smaller union centered on France, Germany, Italy and Spain, and underpinned by stronger coordination and financing, Pacific Investment Management Co. Chief Executive Officer Mohamed El-Erian wrote in a May 15 report outlining the Newport Beach, California-based company’s medium-term economic outlook.
Pimco, a unit of the Munich-based insurer Allianz SE, managed $1.77 trillion as of March 31, including the $258.7 billion Total Return Fund, according to the company’s website.
‘Market has Changed’
A weaker euro could help nations in the bloc as exports would become more competitive. Spain succumbed to its second recession since 2009, first quarter data showed. Gross domestic product fell 0.3 percent from the previous quarter, when it declined by the same amount, the Madrid-based National Statistics Institute said on May 17. Exports of goods and services fell 0.9 percent in the period, the report showed.
“The market has changed its mind from the idea that if Greece leaves the euro is going to break apart, to if Greece leaves what’s left is still going to be a euro,” David Bloom, global head of currency strategy at HSBC in London, said in a May 17 interview. “You are not going to wake up the next morning and there is no euro. A lot of people were worrying about that a year ago and now they realize that’s not going to happen.”
HSBC forecasts that the euro will rise to $1.44 by year-end and $1.45 in the first quarter of 2013 as the Greek crisis moves toward a resolution and the U.S. holds presidential elections amid political disputes about its own fiscal position.
The firm is the most bullish of the 10-largest currency dealing firms, and also in a survey by Bloomberg where the median of more than 50 estimates is for the euro to strengthen to $1.30 by year-end.
Greece’s central bank denied a newspaper report that the institution was planning to impose capital controls.
“The Bank of Greece categorically denies a report in a Sunday newspaper which relates to supposed plans to place a cap on withdrawals and to restrict the movement of capital abroad,” the Athens-based bank said in an e-mailed statement on May 19. It didn’t say where the report came from.
“It would be difficult for the Greeks to announce ahead of time that they are leaving on a specific date because that almost guarantees a bank run,” Shahab Jalinoos, a senior currency strategist in Stamford, Connecticut, at UBS, said in a May 15 telephone interview. “How do you know Spain or Italy or Portugal won’t panic when they see that happening?”
ECB officials decided earlier this year to deal with any Greek exit on an ad-hoc basis rather than devising a set of responses because the fallout would be unpredictable, said three euro-area central bank officials, who declined to be identified because the ECB’s deliberations on the matter are confidential.
Merkel and new French President Francois Hollande said after their first official meeting on May 15 that they wanted Greece to stay part of the currency bloc. Leaders of the Group of Eight nations meeting at President Barack Obama’s retreat outside Washington pushed for Greece to remain and supported boosting growth.
“We agree on the importance of a strong and cohesive euro zone for global stability and recovery, and we affirm our interest in Greece remaining in the euro zone while respecting its commitments,” according to a G-8 statement on May 19.
Yields on Spain’s 10-year government bonds climbed to 6.51 percent on May 16, the highest level November, while Italy’s 10-year yields rose to a more than three-month high after Moody’s Investors Service cut the credit ratings on 26 of the nation’s banks on May 14.
“It may be that if you see Greece going out that the Germans and the ECB ring fence Spain and Italy and come up with an entire plan that brings market confidence back,” Jose Wynne, the head of North America foreign-exchange research at the investment banking unit of Barclays Plc in New York, said in a May 14 telephone interview. “But the market isn’t trading like they believe that will happen.”
Below is a list of year-end forecasts for the euro versus the U.S. dollar by the top 10 currency trading firms, according to an annual survey by Euromoney. The rankings, published on May 9, are by market share.
Deutsche Bank AG $1.30 Citigroup Inc. $1.25 Barclays Plc $1.20 UBS AG $1.15 HSBC Holdings Plc $1.44 JPMorgan Chase & Co. $1.36 Royal Bank of Scotland Group Plc $1.33 Credit Suisse Group AG $1.27 Morgan Stanley $1.19 Goldman Sachs Group Inc. $1.33