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The euro profited today after Greece announced several measures to tighten its massive budget deficit, allowing the confidence towards the Eurozone and making the euro to rank among the best performers in currency markets today.(…)
Read the rest of Is The Greek Crisis Coming to an End? (63 words)

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The Wall Street Journal’s coverage of the Greek dent crisis has focused less on the crisis itself, and more on the markets’ reaction to it. With headlines like “Hedge Funds Try ‘Career Trade’ Against Euro” and “Speculators Bet Record Amount Against Euro For 4th Week” and “Europe Trouble, U.S. Opportunity” – among others – the WSJ has identified a collapse in the Euro (mainly against the Dollar) as one of the most prominent (and profitable!) strategies for exploiting the crisis.

As I mentioned in the last post (”Understanding the Greece Situation“), the debt crisis has become self-fulfilling, not only for Greece, but also for the Euro. In other words, as perceptions abound that Greece is insolvent and the Euro is doomed, Greek bonds and the Euro have lost value, which only makes the crisis worse. It seems that speculators are taking advantage of this phenomenon by making large bets against the Euro. In fact, large is an understatement, as the net short positions against the Euro now total a record $12 Billion, according to the closely watched Commitment of Traders report.

Some analysts have taken such information at face value, noting that “The fact that the shorts got even shorter when they were already at extreme levels highlights just how negative the sentiment is toward euro.” On the other hand, there is evidence (and some degree of admission) that large speculators are now acting in concert to bring down the value of the Euro. The WSJ reports mention private meeting between hedge funds managers and investment banks helping their clients bet against the Euro using derivatives. For those that are skeptical that speculators could really influence currency markets, consider that one man – George Soros – single-handedly forced a devaluation of the Pound in 1992, and made $1 Billion in the process. While the Euro is certainly bigger than the Pound ever was, there are more people watching it than ever, and when there is money to be made -  hundreds of billions of dollars in this case – it isn’t inconceivable that the Euro could suffer a similar fate.

Already, there is evidence that this strategy is working, as the Euro has fallen 10% in less than three months, which is unbelievable for a currency whose daily trading volume is estimated at $1.2 Trillion. In fact, one popular options trade is based on the the Euro falling to parity against the Dollar. Once unthinkable, such a possibility now faces odds of “only” 1 in 14 (based on options premiums), compared to 1 in 33 in November. On the one hand, it’s frustrating to accept the market power that these speculators have. But emotion has no place in (forex) trading, and standing in the way of momentum would be costly.

On the other hand, Euro fundamentals remain strong. To be sure, a currency is only as strong as its constituent parts, and the fact that a handful of EU member states have shaky finances certainly cannot be dismissed. At the same time, the fact that such currencies have no direct control over the Euro is just as important. Before the inception of the Euro, currency traders would be justifiably concerned that a country in a similar position to Greece would deliberately devalue its currency (by printing money) in order to devalue its debt and make it more manageable.

Now, this would be impossible, since the Euro is controlled by the European Central Bank, over which Greece has no power. The current crisis in Greece notwithstanding, “The European Central Bank’s (ECB) resolve to maintain sound money is…important. This is especially true for the ECB, which has a single mandate—price stability—unrelated to fiscal problems.” While there is legitimate concern that the ECB will be forced (or voluntarily) print more money to fund bailouts of bankrupt EU member states, this doesn’t seem very likely, given the history of the ECB. Its monetary policy has always been quite conservative, and it’s no wonder that the Euro has come to be seen as a viable alternative to the Dollar.

In my opinion, the decline in the Euro is mostly baseless, and if it were to continue, it wouldn’t represent the prevailing of logic. Then again, logic is not exactly a word that I would apply to the forex markets, now or ever.

Currency markets operate in funny ways. Greece’s fiscal problems are hardly a new development. During years of boom and bust alike, it ran unsustainable budget deficits. Why investors have decided to fret now – as opposed to last year or next year, for example – on the distant possibility of default, is somewhat mysterious.

After all, the credit crisis exploded in 2008, and conditions now are inarguably more stable than they were at this time last year, when volatility and credit default spreads (insurance against bond default) – two of the best measures of investor risk sensitivity – were still hovering around record highs. On the other hand, the unveiling of Dubai’s hidden debt problems, has certainly provided impetus to investors to re-evaluate the fiscal situations in other highly leveraged economies. In addition, Greece just estimated that its budget deficit for 2010 at 12.7%, 4% higher than earlier estimates, which were also shockingly high. Regardless of 1, the markets are now focused firmly on Greece – and by extension, the Euro.

How serious are Greece’s fiscal problems? Serious, but not insurmountable. Its sovereign debt recently surpassed 125% of GDP, higher than the US, but lower than Japan, for the sake of comparison. Of course, the Greek economy is hardly a picture of robustness. Neither is the US, these days, for that matter, but its size means that it is pretty much immune from speculative attacks on its credit and capital markets. Greece, on the other hand, remains extremely vulnerable to the whims of international investors.

On the whole, these investors still remain willing to finance Greece’s budget deficits; the last bond issue was five times oversubscribed, which means that demand exceeded supply by a healthy margin. Still, interest rates are rising quickly, and spreads on credit default spreads have risen above 400 basis points, suggesting that nervousness is growing and Greece cannot take for granted that future bond issues will be met with such healthy demand.

In this context, in stepped the European Union. In fact, it isn’t even clear if Greece asked for help. As I pointed out above, the Greek debt “crisis” is largely playing out in capital markets, and doesn’t necessarily reflect a change in the fiscal reality of Greece. Still, leaders of the EU were alarmed enough to convene a meeting between the finance ministers of member states, to discuss their options.

After weeks of denial that any kind of aid to Greece was being considered, EU political leaders announced that they were prepared to step in to help after all, but they were vague on the details. There were no ledges of specifc dollar amounts, only hazy promises of support should conditions warrant it. In the end, what was clearly intended to comfort the markets achieved the opposite effect, as investors took no comfort in the “moral support” and worried about the new uncertainty.

It’s premature to say whether this whole episode will threaten the viability of the Euro. Much depends on whether Greece (Portugal and Spain, too, for that matter) can get its fiscal house in order (Among other things, it has promised to reduce its 2010 budget deficit by 4%). More importantly, it depends how, and to what extent, the EU responds to this crisis as a community. The Euro is already 10 years old, and you would think that it would have been accepted already within the EU, as it has by the rest of the world. On the contrary, it remains deeply divisive and fraught with politics. Many of its critics have seized on this opportunity to challenge to raise fresh calls for its abolishment. If the problems of Greece deteriorate to the point that other EU members are actually required to intervene, you can expect these calls to crescendo.

In 2009, so-called commodity currencies – both individually and as a group – registered record-breaking gains. The Brazilian Real and the South African Rand finished up more than 30%, while the Australian and New Zealand Dollars finished up about 25% each, and the Canadian Dollar not far behind. While the outlook for 2010 is slightly less rosy (if only because of the law of averages), investors would still be wise to keep such currencies on their radar screen.

With the appreciations of 2009 canceling out the depreciations of 2008, currency markets are close to “equilibrium.” Going forward, then, investors will to find a rationale other than sheer momentum for making bets. Strong commodity prices represent one such rationale. This is not only the case because currency prices are rising and are underpinning the recoveries in the respective countries that are rich in their production, but also because economic recovery – and “normal” growth as well, for that matter – in many other economies is built precariously on debt and the expansion of sovereign money supplies.

Commodity currencies – and commodities in general – have always held allure as investment vehicles because of their tangibility and necessity. Simply, modern economies depend on commodities for their functioning. Thus, countries rich in natural resources would seem to represent safe bets, since they can be assured of demand both during periods of expansion and during economic downturns.  The strong performance of commodity currencies in 2009 underscores this point, since despite the fact that prices for many commodities are well below the record highs of 2008, these currencies are very close to their 2008 highs.

More specifically, the Canadian Dollar often tracks the price of oil; this correlation will probably only strengthen when the oil sands of western Canada are developed. While rich in many natural resources, it is gold that both Australia and South Africa are famous for, and to which their currencies are often tethered. Brazil and New Zealand deal in a more diverse array of commodities, and the Kiwi and Real often move in tandem with broad-based commodities indexes. There is also the Mexican Peso (oil), the Russian Ruble (natural gas), the Norwegian Krona (oil), and Chilean Peso (copper), but the correlations between these currencies and the respective commodities for which they are famous tend to be looser.

Of course, there are many other economies that are rich in natural resources, but for various reasons (lack of liquidity, fixed exchange rates), their currencies aren’t (as) appropriate for investing. Even the currencies I listed above don’t always reflect commodities prices. For example, Canada’s fiscal problems and South Africa’s monetary easing will arguably weigh down the Loonie and Rand, respectively, in 2010.

For commodity pure-plays, your best bet, then, would be to invest in the commodities themselves. Of course, commodities don’t pay interest and their costs associated with holding them (whether directly or indirectly) and they tend to fluctuate with greater volatility than currencies. Another option is the just-announced WisdomTree Commodity Currency Fund, an ETF composed of a basket of commodity currencies, many of which I listed above.

In October, I wrote about a “separation” that had taken place in currency markets between the “sick” currencies and the “healthy” currencies. At the time, I argued that the former category was comprised mainly of the Dollar and the Pound, with most other currencies healthy by comparison. While I still stand by this paradigm, I would like to revise it slightly. Specifically, I would like to add the Euro and the Yen to this list.

The recent blow-up surrounding the downgrade of Greece’s debt and subsequent explosion in the price of credit default swaps (which insure against default), have shined a spotlight on the fiscal problems of many of the EU’s member states, including Spain, Italy, Portugal, Ireland, and others. The situation in Japan, meanwhile, has been much more gradual, though equally dangerous: “In 1990, Japan’s total national debt load was 390% of GDP. Now it’s 460%. In the interim, the country has suffered sub-par growth and routine recessions.”

The fiscal problems of the US and UK governments as well as the debts of their citizens and companies have long been famous. For that reason, when the sick/healthy paradigm was first proposed, they were the two most obvious candidates. Having conducted some additional analysis, it’s now patently obvious that the same problems affect the EU and Japan. Given that their economies are also in weak shape, it doesn’t really make sense to group them in with the healthy currencies. Canada (and the Loonie, by extension) is also looking sickly, with its surging national debt and record budget deficits. The only reason it is being spared from the list is because of its richness in natural resources; in other words, it has something tangible that it can use to pay its debts.

Among the so-called majors, then, only the Swiss Franc, Canadian Loonie, Australian Dollar, and New Zealand Dollar get clean bills of health. A re-casting of the paradigm, then, would put the super-majors (Euro, Yen, Pound, and Dollar account for more than 75% of all foreign exchange activity) on one side, and virtually every other currency on the other. Given that national debt ratios and interest rate differentials diverge across the same boundary, it’s not hard to conjure a basis for this partition. “The IMF forecasts that gross government debt among advanced economies will continue to rise until 2014, reaching 114% of GDP, compared to just 35% for developing nations.” Adds another analyst: “If you look at currencies as a proxy for growth, then you can anticipate that emerging-market currencies will appreciate against the dollar.”

There is also a correction that is taking place within the group of sick currencies. Investors have come to realize belatedly that a Dollar sell-off doesn’t make any sense against the Euro and Yen, whose economic and fiscal situations could hardly be characterized as healthy. “Against the majors, we’re pretty close to the end, if we haven’t already reached the end of a bear market in the dollar,” asserted one analyst. Given that the Dollar’s demise had all but been taken for granted, this reconsideration isn’t coming natural. Volatility has surged to a 3-month high, and investors are responding by moving funds back to the US. Among the majors, then, it looks like the Dollar is still the “least worst” currency.

Pull up a 1-year chart of the Euro against the Swiss Franc, and you’ll quickly notice a salient trend: the exchange rate has hovered slightly above €1.50 since last March, with three notable deviations. The first occurred last March, when the Swiss National Bank (SNB) intervened in currency markets on behalf of the Swiss Franc, causing the Franc to shoot up instantly by more than 5%. The second took place in June, when the SNB threatened (it may or may not have actually intervened) intervention again, and the Franc shot up in order to create a buffer zone. The final deviation can be seen at the end of December, when a generalized decline of the Euro also manifested itself against the Swiss Franc, as it fell significantly below the €1.50 threshold.

It’s not clear whether €1.50 was ever conveyed by the Swiss National Bank explicitly, or whether it was merely accepted implicitly by the forex markets. Regardless, traders certainly respected this boundary, and for most of 2009, dared not challenge it. At the end of December, as I said, there were two important developments, which bore on the EUR/CHF cross. First, credit downgrades and the (far-off) prospect of sovereign default in the EU set loose a wave of panic, after which the Euro has generally fallen. The second development was a subtle change in the wording of the SNB’s forex policy. Previously, it had promised to prevent any “appreciation” in the Swiss Franc, whereas now it is only interested in stopping an “excessive” appreciation.

It’s not clear whether the Swiss Franc suddenly blasted through the €1.50 because investors believe(d) it was undervalued, or if instead it merely got caught up in the Euro’s weakness. Perhaps, investors realized that now they had an excuse to sell the Euro and no longer had to worry about whether actually doing so would risk provoking the SNB. It was probably a combination of both.

For its part, the SNB (through its President and chief mouthpiece Philipp Hildebrand) is already sending subtle clues to the forex markets about the Franc’s prospects. Hildebrand recently told reporters both that “Raising interest rates would be inappropriate,” and “Since the recovery is still fragile, the current expansionary monetary stance will need to be maintained until the recovery strengthens and deflationary pressures recede.” In other words, those that bet on Franc’s appreciation shouldn’t expect any return on their investment, in the form of higher interest rates.

He also reiterated the SNB’s stance on the Franc more explicitly: “Our policy is clear: we will resolutely prevent an excessive appreciation as long as there are deflationary risks.” Given that the markets called his bluff in December, investors are unfazed: “The difference in the number of wagers by hedge funds and other large speculators on an advance in the franc compared with those on a drop, so-called net longs, was 13,926 on Jan. 12 compared with net shorts of 2,780 a week earlier.”

In all likelihood, the Franc will continue to hover around €1.50, only below that barrier, rather than above it. As long as the Franc remains basically stable, either in literally not moving, or in appreciating at a snail’s pace, the SNB probably won’t get involved. After all, the change in wording to its forex policy is a tacit admission that €1.50 is arbitrary and that perhaps the Franc could stand to gain a little bit, especially in the context of the EU fiscal issues. Not to mention that intervention is expensive and ineffective in the long-term.

If traders really get ahead of themselves, though, Hildebrand has already proven that he’s not afraid to act.

This free Forex video offers a consolidation forecasts for the currency markets today. After going up yesterday, the U.S. dollar is going to be less strong intraday, giving some major currency pairs a chance to correct. Watch this technical and fundamental analysis for details.

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After losing significantly during most of this Wednesday’s session as risk aversion prevailed globally, the kiwi rebounded in currency markets as retail sales advanced in the country reviving the confidence regarding the Southern Pacific economy.(…)
Read the rest of New Zealand Dollar Rebounds on Retail Sales (65 words)

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The Canadian dollar ranked among the worst performers in currency markets today as risk aversion influenced commodities and equities trading, which are strongly related to the loonie’s rates as weak economic data in the country also influenced the confidence towards Canada’s currency.(…)
Read the rest of Canadian Dollar Suffers Huge Impact on Inflation, Risk Aversion (156 words)

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The Brazilian real posted the fourth straight day of decline versus the U.S. dollar as speculations suggest that the Treasury is likely to start a debt selling plan to buy dollars, declining attractiveness for the real in currency markets.(…)
Read the rest of Brazilian Real Declines on Treasury Plans (74 words)

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