Betting Against the Euro: Nothing is Ever a Slam Dunk

January 4, 2012

The news out of Continental Europe was horrendous in 2011.  It was the second full calendar year of an intensifying sovereign debt crisis.  Politicians devised a series of rescue plans that did not address the root imbalances behind the problem and offered insufficient firepower to end sentiment that the common currency is heading for a breakup.  The crisis cost the leaders of Greece, Ireland, Italy and Spain their jobs.  Bond yields among the vulnerable nations skyrocketed and remain at elevations that governments can’t tolerate without outside help. 

Economic activity went from bad to worse, with GDP growth slowing to an annualized rate of 0.6% in the middle two quarters of the year before entering a recession in the autumn that is continuing in 2012.  Europe’s phrase of the year — kicking the can down the road — is in fact a description of the modus operandi not merely of the last year but rather the project ever since its framing in the late 1980s and early 1990s.  Some two decades later, the burden of proof on whether or not the euro survives lies with the optimists to explain why a long trail of missed opportunity and irresponsible behavior should end now.

Coming into 2011, it already seemed to be a no-brainer to bet against the euro, and a number of pundits predicted back then that the euro would touch parity against the dollar at some point during the year.  With the benefit of an extra year’s hindsight, such forecasts seem to have been based on a foundation of very accurate assumptions.  Murphy’s Law to expect anything that might conceivably go wrong to in fact happen played out in spades, and a corner in the saga of misfortune was never turned, not even at last month’s summit of EU leaders.

The year 2012 on paper looks to be even more unforgiving for the euro than 2011, but a note of caution is struck by the fact that the euro didn’t move more sharply last year.  The average value of the euro in 2011 of $1.3923 was in fact 5.0% stronger than the 2010 mean of $1.3258.  In end-December to end-December terms, the euro weakened just 3.3% against the greenback, and two-week changes of that currency pair ranged from a dollar decline of 5.1% between January 10, 1911 and January 24 to a dollar advance of 6.6% from August 29 to September 12.  The average two-week change was a 0.1% dip of the euro.  There was considerable short-term volatility but little sustained cumulating directional movement.  Betting profitably on a drop of the euro required a prescient sense of timing.

Whereas the euro economy was expanding decently a year ago, it’s now contracting even as the U.S. recovery shows more momentum.  Euroland leaders have less remaining time to fix things than a year ago before the euro as we know it crosses the point of no return.  That said, more forecasters are now predicting a stronger euro by end-2012 than dared to make such a forecast of an appreciating euro at this time a year ago.  This shift in the face of worse economic fundamentals underscores the power of recent experience in shaping expectations about future currency movements.  Analysts who got burned betting on a plunging euro in 2011 don’t want to get beat on the same bet this year.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission. 

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