OBSERVERS of the Greece’s fiscal crisis might be forgiven for thinking that there has been little impact on other countries. The credit default swap markets – which measure the perceived risk of a sovereign debt default – have been remarkably well behaved, with the unsurprising exception of Greece.
But if you look more closely at the currency markets, it is a rather different story. As the Greek saga has unfolded, the euro has weakened sharply against the US dollar. Concerns about the long-term stability and cohesion of the bloc have weighed on the single currency, which is now only trading at just above $1.40, compared to as high as $1.51 at the end of last year.
But forex traders should be aware that it is not just the euro that is suffering – emerging European currencies have also borne the brunt. The Hungarian forint has been one of the biggest sufferers, losing almost 6 per cent against the greenback since 13 January. The Polish zloty has lost about 4.5 per cent over the same period, while the Czech koruna fared only slightly better, dropping 3.8 per cent against the dollar.
There are two main reasons why eastern European currencies have been so vulnerable to the Greek debt crisis, which has been one of the biggest stories of 2010 so far. Firstly, emerging European currencies are closely correlated with the performance of the euro because of economic and financial integration between the two blocs.
When considering this, it is worth remembering that the recent falls might only be the beginning. Foreign exchange traders should keep a close eye on what happens in Brussels on 16 February, when the European Commission (EC) reviews Greece’s debt proposals.
If the EC suspects that further troubles could be ahead, or that the proposals are insufficient, then this might push the euro and the emerging European currencies lower in the coming weeks.
Koon Chow at Barclays Capital says that if investors’ concerns over Greece’s debt problems continue and the overnight setback in global equities proves short-lived, then the effect of a further fall in euro-dollar should be localised. Emerging European currencies are expected to feel the greatest pinch from these situations.
Secondly, they may also suffer from the precedent that Greece sets. Chow adds that Greece’s debt problems may lead to the markets reassessing just how valuable is the support that the EU gives to member countries with structural or fiscal problems.
He adds: “The problems with Greece may mean that applications by emerging European countries to join the euro will be scrutinised much more intensively, with the risk of a stricter interpretation of the Maastricht criteria,” the fiscal rules that euro countries must hold to both before and after they join.
The potential for euro membership has boosted investors’ perception of Polish and Hungarian assets, which in turn has increased forex flows into the zloty and forint. The idea that joining the euro could be further off or harder to attain will weigh on these currencies.
Chow also thinks that the market seems to be reading the euro-dollar shift as more of a challenge to emerging European currencies than to other emerging market ones, in part perhaps because they perceive that events in Greece will have a greater impact on the country’s neighbours.
Poland and the Czech Republic are two of eastern Europe’s strongest economies – neither have particularly onerous fiscal nor structural problems and Poland managed to grow 1.4 per cent last year. This would normally suggest that their currencies ought to perform relatively well as investors pick up zloty and forint-denominated assets.
But Chow says that these currencies, and especially the zloty, “are the most liquid in emerging Europe currencies and as a result, prone to be being traded by market participants as proxies for broad regional themes”.
With Greece likely to continue to have a punishing effect on the euro, eastern European currencies will come under further pressure in the coming month or so. Foreign exchange traders looking to take a short bet against them would be better to sell them against the US dollar, which is likely to be a major beneficiary from the falling euro, thanks to the liquidity of the euro-dollar pair.
Those preferring to stick with the more liquid euro pairs will have to weigh up whether the emerging currencies or the euro are likely to fare worse. If recent performance is any guide, then it would appear that shorting the eastern European currencies against the euro would also be a reasonable bet – over the past week or so, the euro has strengthened against the zloty, the forint and the Czech koruna in spite of the continued troubles in Greece.
Greek contagion might have been successfully limited, but the close alignment of the Eurozone and the eastern European countries will prove a problem for their currencies, even if their economies do remain in good shape.