Fueled by growing concern over the Greek debt crisis, the euro is positioned for a severe clobbering at the hands of its safe haven counterparts. The US dollar, Japanese yen and Swiss franc should enjoy disproportionately favorable gains against the euro in the coming weeks of trading or until a meaningful resolution to the debt crisis can be found.
Ongoing concern over the Greek debt crisis and its impact on the Euro in recent trading demonstrates that the fight or flight response is as prevalent in the capital markets as it is in the wild. For some investors, earlier news that Standard & Poor's would not lower its BBB+ credit rating for Greece was a welcomed reprieve from what has become a daily clobbering of the Euro; for the sober investor, however , the news rang hollow, as there was a distinct mortgage-backed security feel to the rating agency's decision.
Going forward, price action in the Euro will remain decidedly bearish until some resolution for the Greek debt crisis is found. While the EU leadership may implement a number of policies in order to contain the issue, most of these policies would be wasted efforts - the economic equivalent of applying a band-aid to a recently amputated limb. There are, in fact, two options available that would quickly resolve this issue. First, the EU can assemble a bailout package for Greece. This option would have an immediate, favorable impact on global markets while restoring to Greece the ability to issue new debt (bonds) at manageable rates. The Euro itself, however, is unlikely to benefit from a bailout in the longer term, as it merely serves to redistribute poor economic conditions across a larger area. Further, it exposes the EU's more stable members to the possibility, if not the obligation, of future bailouts of EU members who poorly mange their economies, exposing a fundamental weakness of the trade bloc.
The second option, though less tactful, would be far more effective: expel Greece from the EU. While this option may offend some EU members, it would immediately restore confidence in the Euro as a global reserve currency. More importantly, the diffusion of Greece's troubles across the EU, which a bailout accomplishes, is more than an economic risk for other member states; it's a political risk as well. EU citizens do not want to see their home economies suffer from the socialization of Greek debt and will gladly voice their disapproval at the ballot boxes should a bailout occur. This potential for social strife and political repercussions demands adequate consideration, as the EU is both an economic and political entity.
While we cannot be certain of which path the EU will take in order to contain the Greek debt crisis, we can be certain that the crisis will remain unresolved for some time. Bailouts are rarely designed and implemented overnight and generally require numerous revisions once implemented in order to have the desired effect. On the other hand, the expulsion of Greece from the EU - or of any member state for that matter - would require months of deliberation before consensus can be reached. Add to these concerns the ever-dependable, inverse relationship between bureaucracy and efficiency and the trade all but spells itself out.
The Trade - Short the Euro
The downside potential for the euro is limited only to the time it will take for the EU to arrive at a meaningful resolution to the Greek debt crisis. As explained above, there should be ample time left to take advantage of this trade. While broad-based declines are expected, the euro is particularly vulnerable to the following safe haven currencies: the US dollar, Japanese yen and the Swiss franc.
The euro has steadily declined against the Swiss franc over the past year despite active SNB intervention efforts aimed at depressing the franc. According to reports that surfaced last week, the central bank is expected to relax those intervention efforts going forward. With the specter of further SNB intervention efforts removed from the marketplace, alongside growing Greek debt concerns, the franc's appreciation against the euro will only intensify in the weeks ahead, making new, all time lows inevitable.
When safety is desired, investors flock to the Japanese yen in droves. Currently trading at 122.50, the EUR/JPY is poised to revisit, and possibly surpass, its 2009-lows, when the pair traded as low as the 112.00 level. As risk aversion grows in the marketplace, which a dropping euro supports, the yen will benefit on two fronts: first, as a safe haven asset that provides shelter against risk; and, second, as an attractive investment opportunity relative to a Greece-burdened euro.
Similar to the yen, the US dollar is a favored shelter among the risk averse. Currently trading at 1.3530, the EUR/USD has downside potential to the 1.2500 level and possibly lower. Like the yen, the US dollar benefits on two fronts against the euro - as a safe haven currency and as an attractive investment. More importantly, for investors who view the Greek debt crisis as additional evidence of an ailing global economy poised for a double-dip, the EUR/USD is especially attractive. Should their double-dip expectations be realized, EUR/USD parity becomes a very realistic target.