Fresh wave of volatility may strike the euro

C ONCERNS about Europe’s economic slowdown have put a halt to the euro’s surge upwards. Since summer lows, the single currency has risen against the dollar, recently testing the $1.30 level. But it has failed to convincingly stay above this level.

In its biannual world economic outlook, the International Monetary Fund (IMF) revised its forecast for euro area growth. It now expects GDP to contract by 0.4 per cent in 2012, and a meagre 0.2 per cent growth in 2013.

The organisation squarely places the blame on the doorstep of policymakers, saying that failure to get a grip of the fiscal situation is making a “slow and bumpy recovery” more perilous, and that a resolution to the crisis “depends on whether European and US policymakers proactively deal with their short-term economic challenges”.

The IMF is not alone in its critique of policymakers. European Central Bank (ECB) president Mario Draghi last week insisted that the ECB has done everything it can to help secure the euro’s survival, and “now it’s really in the hands of governments”. Draghi was hinting at Spain, which has been reluctant to request a bailout from the European Stability Mechanism (ESM), the Eurozone’s permanent bailout fund.

Much of the euro’s recent strength has come on the back of the ESM’s ratification, as well as Draghi’s outright monetary transactions policy, helping to increase confidence in the euro. Spain has used this confidence to delay seeking aid, with minister of the economy Luis de Guindos claiming that they are in no rush, exasperating policymakers and investors.

However, uncertainty remains: whether the ESM can be used to buy “legacy assets” of Spanish and Irish banks is unclear (legacy assets are bad investments that banks made, for example, sub-prime mortgage securitisations in Spain). Managing director of the ESM Klaus Regling has confirmed that legacy assets have not yet been discussed. Traders may want to keep an eye on this spanner; it could undermine the ESM’s effectiveness.

Troubled Greece is back in the spotlight. The country is expected to run out of cash in November and eagerly awaits the next €31bn (£25bn) tranche of its bailout. However, Greece needs to meet budgetary targets to be guaranteed the bailout, which is not likely. Officials are piling on the pressure: IMF director Christine Lagarde yesterday said that there was still more that could be done “on all fronts” before the next tranche is released. Greece now has until 18 October (when the heads of EU states are due to meet) to implement reforms. In a familiar sense of déjà vu, the question is now whether Greece should be given further reprieve. Shavaz Dhalla of Spreadex thinks that, contrary to the rhetoric, Greece will be given flexibility: “You can’t impose this level of austerity and still expect them to service their debts .”

Fortunately, dialogue has been more constructive than in previous showdowns. Yesterday, German Chancellor Angela Merkel visited Greece. How much traders should read into this is debatable. Michael Derks of FxPro says “Merkel is a busy lady and hasn’t been to Greece in three years. You have to ask: why would she bother?”

The volatile nature of the Eurozone implies that traders should be cautious not to overextend themselves. Derks believes that the strategy should be to “buy into euro weakness, but not in a substantial way”. He sees scope for euro appreciation against sterling over the next few months and it could hold its own against the dollar. But traders should not get complacent about this period of relative calm, which may turn out to be an aberration.