The Euro sculpture in front of the headquarters of the European Central Bank in FrankfurtALEX GRIMM
Currency markets are on edge as speculation swirls over whether a two-day meeting of the member states of the European Union beginning today in Brussels will be able to come to an agreement on a proposed bailout of Greece.
The flight-to-safety trade in the currency markets was given a push yesterday by Fitch Ratings' decision to lower the credit rating of Portugal, which along with Ireland, Greece and Spain are collectively referred to by currency traders as the PIGS of the euro.
The Canadian dollar was among the currencies caught up in the trade, declining almost 0.8 per cent against the high-flying U.S. dollar, while the euro sank another 1.2 per cent against the greenback. Liquidity in the greenback makes it the currency of choice for investors when markets are in turmoil.
Last year the euro was being talked about as a potential rival to the U.S. dollar as a reserve currency alternative, but during the past four months the euro has plunged 12 per cent against the dollar.
"I think the big issue for investors is that we have had a rapid change in sentiment," said Shaun Osborne, chief currency strategist with TD Securities Inc. "I think the market is starting to more fully price in the risk."
Although it is not realistic to look for a credit default from Greece, Mr. Osborne thinks it will be a bailout supervised by the International Monetary Fund, not the European Union.
The problem confronting the EU is that Germany would need to be a big contributor to a bailout, but there is political resistance in that country to helping out Greece, he said. "France has been a strong proponent of some sort of aid to Greece," Mr. Osborne said.
How will the market react?
The split between France and Germany raises doubts about the future of the European Monetary Union, said Dennis Gartman, editor of the Gartman Letter. From a technical point of view the euro could weaken further now that "the 100-day moving average of the euro is now crossing downward through the 200-day," he said in a report to clients.
"Germany remains politically and philosophically unwilling to come to Greece's aid and [German Chancellor Angela Merkel]has no choice but to play very, very hardball with [Greek Prime Minister George Papandreou] for her constituents demand it," he said.
Greece wants help to reduce its borrowing costs, said Mark Frey, vice-president of foreign exchange trading for Custom House, but the EU's apparent unwillingness to step in to provide assistance brings into question the validity of the European Monetary Union. Greece is seeking low interest-rate loans in order to reduce its borrowing costs, which at 6.36 per cent on 10-year bonds are 328 basis points higher than Germany's borrowing cost. (A basis point is 1/100th of a percentage point.)
The lack of agreement by the EU to deal with the Greece problem along with the potential of other countries running into financial problems is likely to result in continued downward pressure on the euro, Mr. Frey said. "I would not go long the euro no matter what at this point," he said.