How to Trade Greece’s Currency Conundrum
Greece is back in the headlines, threatening to sink the euro, if not the entire European Union. The whole situation can be a bit complicated, so I tried putting myself in your shoes, wondering the kind of questions you might have. More importantly, there’s a big trade brewing in this Greek debt debacle – today, I’ll cover how you can take advantage of it…
In simplest terms, what’s happening in Greece right now?
Think of it like this: Imagine a major state like California went bankrupt and needed a bailout from the federal government — but Congress was considering not doing it. A crisis of confidence would arise, both for the United States and the state involved. Investors would fear that the U.S. deficit would grow even bigger, and that would drag down U.S. growth expectations.
This is the situation playing out in Europe. Greece is having trouble paying its bills because its spending is way too excessive. How bad is it? Consider this — Greek citizens are able to retire (and collect government pension benefits) at just 53 years old! Needless to say, Greece is on the hook for decades of unfunded entitlements.
The result is a budget deficit (public debt as a percent of GDP) of 120%. To put that into perspective, take a look at the chart below. Compared to other European nations, including Bulgaria, Estonia, etc., Greece’s budget problems are off the scale.
So the country needs a bailout to meet the strict requirements that being part of the eurozone imposes. But not surprisingly, Germany, France and other members of the European Union don’t want to bear the cost of Greece’s excesses. And now Greece is openly threatening to leave the euro.
The reaction is fear of disruption to the European economy, a flight of capital away from the euro and an increase in the cost of business. Lack of trust is causing the Greek bond market to price in a hefty fear premium.
What’s at stake?
The question of what’s at stake certainly depends on the stakeholder…
For Greece, it’s a mess. The country can’t get out trouble the way other countries do, by devaluing their currency. As part of the eurozone, it has no control over the euro’s value.
So instead the country has been forced to make massive budget cuts, which is politically hard in a socialist welfare state. The Greeks have grown used to their government entitlements, and they don’t want them taken away. It’s like pulling a pacifier from a baby’s mouth.
The situation is also a big headache for banks and other holders of Greek sovereign debt. Greece’s money problems could lead to default. As the old adage says, if you owe a bank a small amount of money, you are in trouble. If you owe the bank a huge amount of money, they are in trouble! At the most extreme, Greece leaving the euro would cause an even bigger disaster.
That’s why Greek bonds are registering shocking levels. Last week, Bloomberg reported that the yield on Greece’s 10-year bond rose to 15.8% — twice the rate it was a year ago. The country’s two-year bond yields almost 25%.
As the Financial Times put it:
Greece is at present getting the worst of all possible worlds: it is incurring the political and economic costs of austerity without gaining investors’ confidence that there is light at the end of the tunnel. It is on financial life support and on its way to becoming a ward of Europe. Yields on Greek paper suggest a default is near-certain, which cannot but dampen investment in the country.
Then there are the other debt-ridden eurozone nations, Spain, Portugal and Italy. They face the fear of contagion. With all the attention on debt, they can’t escape the scrutiny of the bond-rating agencies. So they, too, need to worry about a downgrade in their sovereign debt risk.
What does this mean for the greater eurozone — and the euro as it relates to other currencies around the world?
The Greek situation will be very tough for the eurozone because any solution is a drag on its collective economy. European Central Bank President Jean-Claude Tichet is trying to control inflation and growth, which means interest rates need to go up. But Greece needs the stimulus created by lower interest rates.
For these reasons, Europe remains very uncompetitive compared to emerging markets right now, and they have to make structural reforms to keep capital from leaving the euro in the long run.
What does that mean for currency traders?
Quite simply, this is all great news for traders. Remember, the keys to big currency profits are surprise and uncertainty. And the clash of expectations between Greece and the eurozone play right into those two keys. Higher interest rates in the eurzone would create greater value in the euro, but the ongoing problems in Greece counter any of that optimism.
The result is volatility for the EURUSD, and greater ranges. Just look at the EURUSD daily chart.
The sentiment battle is under way. It has a 600 pip wide range between highs and lows in a downward channel.
This is a prelude to a breakout… so watch for bounces!
[Editor’s Note: If you’re not familiar with currency trading, Abe’s mastered a simple yet powerful way to tap moves in the currency market with limited risk and incredibly quick turnaround times. As a result, Abe’s service is the only one of its kind in North America right now. If you’d like to learn more, I’d strongly suggest you click here to learn how to take advantage of the flux in the euro.]
May 31, 2011
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