Euro Risk Concealed as Greece Lurches Toward Currency Union Exit

Updated on
Does Greece Matter to the FX Market?

To look at the euro right now, you’d never guess its very existence is being threatened.

As Greece teeters on the brink of crashing out of the monetary union, Europe’s single currency is headed for only its second monthly gain versus the dollar in a year. Strategists give a variety of reasons for its resilience, from money managers canceling euro hedges as they dump bonds and stocks to optimism Greece and its creditors will come to an 11th-hour bailout deal, possibly after an emergency summit in Brussels on Monday.

Longer-term, though, the picture looks less rosy, with the premium on options protecting against a euro decline surging to the highest since 2012. A Greek exit, or Grexit, would send the euro zone into uncharted waters, marking its end as a 19-nation trading bloc and potentially placing the entire currency union in jeopardy.

“People aren’t really properly pricing in the risk of a Grexit,” said Eimear Daly, a currency strategist in London at Standard Chartered Plc. “The market is tired of trading these headlines and it’s also a question of, ‘How do you play a euro without Greece?’”

A new Greek proposal to end the deadlock on the nation’s bailout drew a guarded welcome from European leaders as they gathered for the Brussels summit.

‘Reversible’ Project

For the EU, the big concern about Greece leaving the euro is contagion: that it would prompt other nations to reconsider their own places in the monetary bloc.

It would show that, as a political project, “the euro certainly is reversible,” said Neil Jones, head of hedge-fund sales at Mizuho Bank Ltd. in London.

For Greeks, the worry is their nation may be headed back to the days before 2002, when the euro replaced a drachma with far less international spending power.

The euro has appreciated in fits and starts this month as talks convened and broke up without agreement. Last week, with the June 30 expiry of Greece’s current bailout approaching, the single currency climbed three days out of five. On Monday, it was little changed at $1.1361 as of 10:02 a.m. New York time -- up 8.5 percent from a more than 12-year low in March.

Euro ‘Immune’

“The news flow out of Greece and Brussels is having almost no impact” on the euro, said Ulrich Leuchtmann, head of currency strategy at Commerzbank AG in Frankfurt. “Whatever you think about the probability of a Grexit, that probability has changed in the last week. Nevertheless, the euro has been immune to these changes.”

A Greek exit may also hurt the euro’s status as a global reserve currency, a position that’s already been undermined by its long-term slide. Global central banks cut their euro holdings by the most on record last year, and it now accounts for just 22 percent of worldwide reserves, down from 28 percent before Europe’s debt crisis five years ago, according to the International Monetary Fund.

Eric Crittenden, who manages $272 million as chief investment officer of Phoenix, Arizona-based Longboard Asset Management LLC, said a Greek exit may actually boost the euro because the currency’s weakest member would have left.

Weakest Link

Longer term, most strategists see the euro resuming its 13 percent over the past two years because of the political risks and as the European Central Bank reflates the economy with record stimulus. Commerzbank predicts a year-end level of $1.04, while Standard Chartered is more bearish with a forecast of $1.03.

The premium on contracts to sell the single currency in three months’ time over those to buy widened to 2.8 percentage points, risk-reversal prices compiled by Bloomberg show. That’s up from 2.3 percentage points on Thursday and is the highest since June 2012.

For now, though, the euro is being supported by investors selling the region’s assets and unwinding the hedges that protected them against losses, said Andreas Koenig, head of European foreign exchange at Pioneer Investments in Dublin.

“The whole FX world is asking why the euro is so resilient,” said Koenig, whose firm oversees about $256 billion. “The strange situation comes up that European equities go down but you have to buy euros. When little other activity is in the market, these flows can move the market.”

Hedge funds have meanwhile cut net bets on a weaker euro by more than half from a record-high at the end of March, according to the Commodity Futures Trading Commission in Washington.

“If there’s a crisis going on in Greece nobody appears to have told the currency market,” Steve Barrow, head of Group-of-10 strategy at Standard Bank in London, said in a June 18 note. “The euro is rock steady.”

For more, read this QuickTake: Common Currency's Existential Crisis

Before it's here, it's on the Bloomberg Terminal. LEARN MORE