Giulio Tremonti
Giulio Tremonti REUTERS

Despite the largely encouraging news coming out of the Eurozone this week, the European debt crisis is far from over.

In fact, the fair value of the euro against the U.S. dollar is 1.25, which is 7 percent below the current levels, according to Nomura Securities International. In the fourth quarter, Nomura expects the euro to slide towards that level.

Nomura believes the European debt crisis will continue to deteriorate on the feedback loops among three forces: the indebtedness of peripheral Eurozone sovereigns, the tensions in the European banking system, and the weak economic growth of the Eurozone.

Nomura believes the encouraging recent news out of the Eurozone – reports that authorities are discussing ways to recapitalize European banks and the European Central Bank’s new measures to increase liquidity in the financial system – are not enough.

The recapitalizing of banks may be too little and too slow because of “obvious institutional constraints,” referring to the political fragmentation of the Eurozone.

Recapitalizing Italian banks may not even work because of their concentrated exposure to Italian sovereign debt.

And while the ECB reintroduced two liquidity measures, it appears reluctant to expand the size of its bailout fund ESFS through leverage.

Nomura also noted that the accumulation of euros by emerging market central banks have slowed since July, partially due to capital flight out of these countries.

It estimated that emerging market central banks switched to selling $5 to $10 billion worth of EUR/USD per month recently to purchasing $25 billion worth of EUR/USD per month from January to July.

Nomura said while there is no way of telling whether or not this trend will continue, high frequency indicators suggest it will.

Lastly, there is the tail-risk of a Eurozone breakup.

In light of all these negatives against the Eurozone, Nomura’s models of risk premium and price level suggest that the fair price for EUR/USD is around 1.25.