I said on April 22nd that the euro was headed “to the lower 1.20’s if not below that” and I see no reason to change my opinion at this time, especially after Tuesday’s credit rating downgrades. What’s happened is that the unthinkable has become thinkable: restructuring.
Standard and Poors lowered Greece’s credit rating to BB+ from BBB+, marking the first time that a euro member has lost its investment grade rating since the common currency’s 1999 debut. S&P also reduced Portugal by two steps to A- from A+. Additionally, S&P assigned a recovery rating of 4 to Greek debt issues. This means that S&P expects on average that debt holders may get only 30-50% of their investment back in the event of a debt restructuring or payment default.
The reason why credit downgrades are so important is because of the system now in place whereby European commercial banks buy Greece’s debt and use it at the ECB as collateral for freshly printed money. As long as at least one rater keeps Greece at BBB- or above, the ECB will keep allowing this exchange to happen.
No one outside of Europe’s commercial banks and the ECB knows how much of Greece’s debt is being held by these institutions. But there seems to be a growing realization that the bond holders are primarily banks and that much of the EU/IMF funds will eventually wind up in the banks’ vaults. Greece is really not being bailed out. At best it is being forced to boost its savings so it can service its debt, and lent money so it can service its debt. The backstop for Greece may really be another backstop for European banks.
The bottom line, however, is that what’s currently on the table from the EU/IMF (which Germany still hasn’t made a decision on) is not going to be enough to cover Greece over the next 3 years. Even worse is that the risk of contagion is growing to other indebted nations like Portugal, Spain and Ireland. Credit-default swaps on European sovereign debt surged to records, with contracts tied to Greek government bonds climbing 111 basis points to 821 and Portugal rising 54 basis points to 365. Greek two-year note yields soared to almost 19% and Portugal’s jumped to 5.7%.
Worsening the situation is that with Greece now effectively priced out of the private market, the lack of a single fiscal authority in the EU is creating an enormous uncertainty. The suspicion now is that the IMF is working out some sort of orderly restructuring which would allow Greece to extend payments out several years until it can get the debt/GDP ratio under better control.
Here’s How I would Trade This Move:
I set up a Fib on Tuesday’s candle which I believe will help with an entry. Since the bias is short, what we want to do is to measure where price could retrace to before resuming its downward trajectory. As you can see, the high so far today has been very close to the 23.6 retrace level. We could see this level tested again as resistance, and that is the first place I would look to take a short trade. If that fails to hold, the next place I would look to short from would the 38.2 level.
©2010 FX Instructor Forex Blog - For Traders, By Traders. All Rights Reserved.