Euro’s Fate Next Week Hinging on PSI Deal

January 20, 2012

At this moment, reports leaking out of the PSI talks between Greece and its private sector creditors suggest that prospects have improved for a deal before the end of this weekend.  PSI is the acronym for "private sector involvement," which in turn euphemistically refers to a voluntary exchange of existing Greek debt for new instruments in which creditors would reluctantly accept a large write-down of principal and a lower interest rate on their holdings.  The total "haircut" appears likely to exceed 60%, not the originally muted 50%, and could be close to 70%.  A PSI deal is one of several essential conditions that must be met if Greece is to forestall defaulting in late March.  Significantly, it is the stage in the gauntlet of steps that is presently front and center, so its attracting a huge amount of attention.  If investors have learned anything from the drawn-out euro crisis, it is to expect constant twists and turns.  Markets rally when deals are announced, only to falter on sober realizations that it will still be miraculous if Euroland emerges in its current state once all the dust settles.

If things ultimately go poorly and an unplanned and unmanaged break-up of the common currency grouping occurs, world financial markets are likely to experience even more havoc than was felt in 2007-09 from the subprime mortgage crisis.  Unlike then, governments would not be able to defuse the resulting chain reaction of escalating damage to financial markets and real economies.  The dollar and Treasury securities benefited from collapsing appetite for risk in the first episode.  From a peak of $1.6038 on July 15, 2008 to a trough of $1.1878 on June 7, 2010, the euro plummeted 25.9% and remains even now in the lower half of that range.

Friday the 13th, one week ago, delivered two major pieces of bad news: S&P downgraded its rating on nine euro area members and the EFSF, and then Greek PSI talks collapsed.  EUR/USD hit a 2012 low of $1.2623 that day, 2.4% below the end-December level and 15.5% weaker than the 2011 peak of $1.4939.  News surrounding the twin scares of Friday the 13th improved in the ensuing week, however.  A series of Euroland sovereign debt auctions were received surprisingly well, and the PSI talks were resurrected and now seem on the brink of yielding an agreement.  Trusting in these good vibrations and fed by a continuing diet of better-than-forecast U.S. data, which promote risk taking, investors bid the euro up almost 3% to a high of $1.2988 today.

In coming days, investors will need to verify that such trust was warranted.  The euro’s rally this past week will otherwise prove short-lived, and ground above the psychological $1.30 level will prove elusive.  Foremost, investors want to see a PSI deal inked and learn that it is acceptable to other parties whose support is crucial to the postponement of a Greek default.  Reactions of the IMF, ECB, and German government will be monitored carefully.  IMF Director Lagarde and German Chancellor Merkel have scheduled talks on Sunday, one day ahead of a meeting of EU finance ministers.  Analyst critiques of actions adopted will exert great influence on the currency markets, and so will economic data being released next week.  The economic calendar features first estimates of U.S. and British fourth-quarter GDP, the preliminary findings of Euroland’s January purchasing manager surveys, several more U.S. housing market indicators, and Japanese retail sales, consumer prices and trade figures.  The Bank of Japan, Federal Reserve and Reserve Bank of New Zealand are three of the central banks planning interest rate meetings next week.  A closure all week of Chinese markets for the Lunar New Year may dampen the volume of activity.

Currency markets are showing more residual risk aversion than equities.  Amid all the market noise from week to week, day to day, and hour to hour, European currencies continue to grind lower against the dollar in spite of other signs of lessening risk aversion such as the good start in 2012 of share prices.  The table below shows period averages since mid-2011 for the dollar against the euro, Swiss franc and sterling.  The pattern of dollar strength/European weakness has been consistent and remains on-going. 

  3Q11 4Q11 2012 to Date
Euro $1.4137 $1.3474 $1.2820
Sterling $1.6097 $1.5721 $1.5438
Swiss franc CHF 0.8253/$ CHF 0.9126/$ CHF 0.9529/$

Technical considerations may play an important market role in the period ahead for several key currency pairs. 

  • The aforementioned $1.3000 per euro level has been planted in investors’ minds as the dividing line between strength and weakness.  The euro fell below that barrier about a month ago for the first time since mid-September 2010 and has since spent more time below the threshold than above it.  Even with a PSI deal, a sustained move back above $1.3000 will be difficult to achieve.  Considerable uncertainty surrounds Europe, and optimism about China and the United States may become more guarded.


  • The dollar is presently near par against the Canadian and Australian dollars.  The loonie has been a tad weaker, ranging from 1.0320 to 1.0070 per USD so far this year.  In contrast, the Aussie unit is slightly above, fluctuating so far this month from as strong as USD 1.0475 to as low as $1.0140.  In each case, however, unity seems to act like the center of a gravitational field preventing markets from straying too far away.


  • An analogous situation surrounds EUR/JPY 100.0.  After sliding under that level on last year’s final trading day for the first time since December 2000, the euro dropped to a low of 97.05 on January 16.  Earlier today, the euro printed as strongly as JPY 100.36, but it is marginally under 100.0 again at this writing. A few massive single-day interventions in USD/JPY by Japan’s Ministry of Finance has preventing the yen from strengthening to 70 per USD or even 65 per USD.  As Japan’s trade and current account surpluses fade, officials there have become increasingly alarmed about the yen’s persist strength above their desired levels, even as U.S. officials have voiced greater complaint about the intervention.  Don’t be surprise if the intervention shifts to EUR/JPY in an effort to keep that pair near 100.


  • Yet another pair that’s drawing considerable interest is the Swissie/euro.  Swiss officials imposed a 1.2000 franc ceiling last September 6.  It hasn’t been breached but has moved very near that line of defense this year.  The franc’s average value since September 6 is 1.2237 per euro.  With Swiss deflation fears rising, speculation that the franc’s ceiling might be repegged to 1.2500 depressed the currency to a recent low of 1.2442 on December 7.  A scandal at the Swiss National Bank that led to the bank president’s resignation has ironically removed a deterrent from franc speculators.  It’s unlikely that bank officials would want to change their target now.  In fact, investors have become increasingly predisposed to seeing how much intervention and other drastic steps the Swiss central bank’s leadership is prepared to expend if 1.2000 were to be challenged. On January 12, the euro dipped below CHF 1.2100 for the first time since September 20, and it has touched ground below 1.21 on each subsequent day including 1.2064 today.


  • Another currency that’s straddling a big figure is the kiwi.  NZD/USD today has traded between 0.8059 and 0.7994.  This past Tuesday saw New Zealand’s currency print above 80 U.S. cents for the first time since November 1, 2011.  2011 was an incredibly volatile year for the kiwi, which trading in a 24%-wide range from as low as USD 0.7113 to as high as USD 0.8840.  0.80 is not only a big figure but approximates the kiwi’s average value since of USD 0.7915 since the start of 2011.  Like the other big figures mentioned above, it may take on the qualities of an equilibrium while markets wait for the never-ending era of high uncertainty to let up.

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

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