Speculative positions are increasingly bearish on the euro and our short euro-long US dollar exchange-traded currency accounted for over 70 per cent of turnover last week.
The latest uptick in risk appetite, reflected in strong equity gains and a fall in the yen, appears at odds with the economic backdrop. There has been some improvement on the economic front, but it is unclear at the moment whether the recovery can be sustained without continued government and central bank support. With sovereign debt risk rising, how much longer can governments continue their stimulus programmes?
It is clear from the recent Greek crisis that markets will not tolerate the current lack of fiscal discipline indefinitely. But investors are also quick to shy away from the currencies of those economies showing sluggish growth. The pound is a prime example of this, with our short sterling-long dollar contributing nearly 15 per cent of trading volumes over the past week, as weak growth and high inflation has driven fears of possible stagflation in the UK.
Sovereign risk is unlikely to go away for some time. Fiscal deficits in most developed economies are rising rapidly and debt levels are increasing. The end result is likely to be a growing disparity between currency performance, so countries with fiscal room to manoeuvre will outperform those without.
One currency that appears to have been overlooked is the Norwegian krone. Given Norway’s solid fiscal position and improving economic fundamentals, it may be a currency worth looking at.