The fortunes of the euro took an abrupt about face earlier Thursday after German government officials made strong overtones about fiscal and financial rescue packages that might extend beyond its borders. Currency traders have reacted to the preliminary overture with a huge collective sigh of relief over the future stability of the single European unit where some had predicted a break up had the plight of several member economies been allowed to deteriorate. Implied option volatility on the euro jumped as demand for puts surged with investors eyeing an assault on $1.2337 against the U.S. dollar.
We noticed a surge in activity out of the blue late Wednesday when investors turned to the April options contract to snap up more than 14,000 put options with a strike price of $1.25. This seemed to be acting as a drag on the underlying euro, which fell to $1.2514 late in the day. The near 4.0 premium implied a drop beneath $1.21 for the currency over the next eight weeks. Today investors are feeling a distinct thaw after the recent avalanche of fear had buried the currency, almost costing the euro a fresh cyclical low.
When a story like this comes along, it's hard to ignore. For the longest time many commentators have been scathing of the reluctance of the ECB to adopt an appropriately relaxed stance. Even this week some members have remarked on the pitfalls of reducing monetary policy to the bare bone. The apparent willingness of Germany's politicians to act in a coherent manner has to be seen as a positive and from that perspective one understands why the euro might be spared further weakness. It's easy to make the prediction that just as with any other government package, this one won't work, but for now it's grabbing the headlines and provides fodder for not just the euro bulls but risk appetite bulls.
Earlier this week the German cabinet approved plans to use its powers to save what it termed 'systemically relevant' banks. Presumably there must be some candidates unsuitable implying bankruptcy if the bank doesn't fit the bill. Later the parliament will vote on a stimulus package aimed at generating business from the ground up, adopting tax relief and loans to boot.
Today's news comes hot on the heels of the selling catalyst for the euro in which Moody's warned that Europe's banks face downgrades courtesy of exposure to Eastern European corporate and sovereign debt. We have to point out that reaction to most plans recently unveiled tends to run from hot to cold as investors work out that the steps are hard to implement and often represent a mere drop in the ocean. For sure the focus on Ms. Merkel's Berlin press conference will steal the limelight, but we doubt whatever comes out of this resolve will ultimately prevent further pan-European weakness.
The yen continues to weaken overnight and despite the drop in the value of the dollar, the yen manages to outflank it trading at ¥94.12 Thursday. Euro/¥ has rallied firmly and is within an inch of ¥120.00.
The Australian dollar reached 65.23 U.S. cent from 63.70 yesterday on hopes that a decline in the value of the American dollar would herald global recovery. One can't blame forex investors for responding this way. It's not illogical but it does highlight the philosophy of trading that proves that investors will lean over one side of the ship for as long as possible until some other piece of news comes along forcing them to rush en masse to the other side, rocking the stability of all passengers. The Canadian dollar also rose against the U.S unit, which today buys C$1.2518.
The Swiss franc is slightly stronger against the dollar today after UBS agreed to pay the SEC in response to an ongoing probe into whether the bank encouraged U.S. investors to hide from the IRS. Fears that the outcome will provoke more international governments to dig beneath the inherent haven of Swiss banking activities isn't a positive for the franc, today trading at $1.1735. Couple this with recent comments from the SNB and government that it would prefer a more competitive currency in the current economic environment and the earlier dollar rally to $1.1825 makes a far more compelling story.
Whether or not the German show of strength ultimately amounts to stronger European ties remains to be seen. Today the euro wins a reprieve from a competitive devaluation. We await for this story to unfold.