EURO RETREATS ON SOVEREIGN DEBT WORRIES

DIRECTOR OF CURRENCY RESEARCH, GFT

JUST as euro-dollar broke through the key $1.4000 level on anticipation of an upcoming European Central Bank (ECB) rate hike, Moody’s downgraded Greece, bringing the rally to a sudden halt as sovereign debt fears returned to the currency market. On Monday, Moody’s reduced Greece’s sovereign debt rating by three notches to B1 from Ba1 classifying it as “highly speculative”.

Moody’s noted that “the fiscal consolidation measures and structural reforms that are needed to stabilise the country’s debt metrics remain very ambitious and are subject to significant implementation risks.” It added that conditions attached to continuing financial aid after 2013 will reflect solvency criteria that the country may not satisfy, and result in a restructuring of existing debt.

The Greek government quickly countered stating: “At a time when the global economy is fragile and market sentiment is sensitive, unbalanced and unjustified rating decisions such as Moody’s today can initiate damaging self-fulfilling prophecies and certainly strengthen the arguments for tighter regulation of the rating agencies themselves.” However, the damage had been done and euro-dollar retreated off its highs as currency traders contemplated the possible ramifications of the downgrade.

For euro bulls, the downgrade of Greece could not have come at a worse time. Just last week, ECB President Jean-Claude Trichet practically promised the market a rate hike at the ECB’s next meeting in April, creating the foundation for the current rally. With America’s Federal Reserve still on the sidelines despite improving US economic fundamentals, the euro has been rallying against the dollar on interest rate differentials as the spread between US and German two-year bonds continued to widen out in favor of Europe.

However, Portugal has €4.342bn in bond redemptions coming in April and Greece has €8.22bn due on 20 April. If the credit markets move against both countries ahead of the event, the ECB may be forced to delay its tightening policy – which could trigger a much more significant correction in euro-dollar.