WHAT a difference a week makes. Last Wednesday, euro-dollar at $1.5000 looked inevitable, as rate hikes were the only focus of the market. This week, all eyes are on the debt problems in Greece, as fears about its exit from the euro have the pair trading much closer to the $1.4000 figure.
Greece, which appears to be on the verge of insolvency with a debt to GDP ratio approaching 200 per cent, is the Achilles heel of the European monetary union. Saddled with enormous debts, a shrinking economy and porous tax system, Greece is unable to service its credit and cannot meet the IMF fiscal budget targets. Furthermore, a significant portion of Greek debt lies on the books of French and German banks. If they were forced to mark those assets to the market, the losses would create enormous financial problems for core European economies as well. That’s why an observer of the Greek financial scene remarked last week that Greece could trigger a “Lehman” like event in European credit markets if it were to exit the union.
The volatility in euro-dollar underscores the seriousness with which the market is treating the Greek situation and suggests that policymakers will have no choice but to work out some sort of financing arrangement at the Ecofin meeting next week in order to pacify the capital markets. However, any arrangement must be comprehensive in nature, encompassing Portugal and Ireland as well. If EU officials decide to provide preferential terms only to Greece, the political difficulties of such a move will be far greater than the economic costs. Until then, euro-dollar is likely to trade in limbo, with little possibility of a rally back to $1.5000 as sovereign debt concerns outweigh risk appetite flows.
Next Thursday, 19 May, I will be giving a free seminar in conjunction with City A.M. titled Actionable FX Strategies for the Retail Trader in which I will discuss the euro-dollar situation in much greater detail. Be sure to register – at www.gftuk.com/cityam – and join me at the Grange St Pauls Hotel. The presentation starts at 8.00am.