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Thinking Long and Hard About Shorting the Euro Again

Monday, 12 July 2010 09:31 AM Current | Bio | Archive

I’m starting to consider shorting the euro again.

On June 22, I wrote “if the EUR/USD were to advance further from here on, my inclination to sell would begin to rise commensurably — and certainly were the euro to approach $1.2645.”

So we are in the EUR/USD zone I referred to in June.

Besides that, but now that Goldman Sachs wrote to its clients it is now bearish on the dollar, to me that’s one of the reasons to start shorting the euro again.

Keep in mind that Goldman ticked the EUR/USD trade to within a few hours of the euro’s multiyear low when it issued its downgrade for the euro from $1.35 to $1.15, which was bad timing, at least.

I have some suspicion that Goldman could be exactly doing the opposite of what it’s saying and is now buying dollars and selling euros.

We’ll see what comes out.

If “double dip” fears should take hold, that would likely herald a more indiscriminate reaction in FX markets, which would result in broad dollar strength resulting from significant ‘risk-off’ and safe-haven flows.

Along these lines, I would also like to mention the Swiss franc (CHF) would no doubt also be well supported. But regardless of the downside scenarios, there are good reasons for the Swiss franc to appreciate further. The Swiss franc continues to be well supported by its good domestic fundamental story as well as a reduced threat of FX intervention, following the Swiss National Bank’s (SNB) unusually large interventions in May.

In this context, it may be enlightening to mention the Swiss National Bank may have suffered paper losses of up to 10 billion Swiss francs ($9.48 billion) on the back of its intervention in the currency markets to restrain the value of the CHF.

It now seems they have put on hold their currency interventions.

Another possible implication that cannot be overlooked of a sharper risk sell-off would be the prospect of sharper Emerging Markets (EM) FX depreciation and the impact on inflation, which would limit Emerging Markets central banks their flexibilities on monetary policy.

Also, one of the main issues is the fact that the euro zone still has potential political issues to contend with in the near-term.

Don’t forget we have only just seen the initial stages of the fiscal adjustment process in the euro zone and there is still the potential for heightened tension linked to unpopular policy and reform measures further down the road in France, Spain, Italy, Greece, etc.

After the Committee of European Banking Supervisors released more details of the keenly awaited exercise to stress test the euro zone’s banking industry (publishing the names of the 91 banks being probed and a broad idea of the stress scenario), the European media announced that the stress tests are “distressing” but at the same time appear to be a whitewash, and are surely not intended to solve the problem the banks are facing.

The so-called tests do not constitute extreme scenarios, especially on European sovereign bonds, but on the contrary are rather very accommodating conditions, which the banks are almost certain to fulfill.

Commerzbank already says that if everybody ends up surprised at how well the banks have passed the tests, there is a real danger that this would backfire.

The stress tests assume a worst-case scenario for Greece that the bonds are traded at a discount of 17 percent when they are already, in the real world markets, discounted at 25 percent.

In “honest and trustworthy” English this means for Greece that the worst case scenario that is applied in the stress tests is completely unrealistic.

According to Deutsche Bank only two of the 91 banks to be tested are likely to fail the broad tier 1 (Tier 1 is the core measure of a bank's financial strength from a regulator's point of view) test 6 percent threshold.

Unfortunately, the euro zone bank stress tests clearly sidestep the issue that probably matters most to investors and creditors, which is what would happen to the banks if a Greece, or a Portugal or a Spain actually defaulted or had to “restructure” their sovereign debts?

It's all very well to tell banks that they need to assess the impact on their capital of a fall in the market price of Greek government debt, or Portuguese debt, or Spanish debt. But the problem here is what if these banks don't use “mark-to-market” valuations for all or some of their sovereign bond holdings, then this would be an irrelevant test, which in my opinion it will be.

And what’s even worse, in the meantime, the EU’s authorities continue to rely on the idea that everything would be well if the markets fully trusted them. My question is; why should I trust them? The stress test results that are due on July 23 will probably not achieve the success of last year’s more transparent U.S. tests, which triggered by the way a recovery in U.S. bank stocks.

Yes, the euro so far seems to have benefited from “buy the rumor.”

On July 23, it could well be that this could easily turn into “sell the news.”

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I m starting to consider shorting the euro again. On June 22, I wrote if the EUR/USD were to advance further from here on, my inclination to sell would begin to rise commensurably and certainly were the euro to approach $1.2645. So we are in the EUR/USD zone I...
Monday, 12 July 2010 09:31 AM
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