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Why is EUR Lower if Europe Agreed to New Bailout for Greece?

Last updated 2/21/2012 9:06 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

For the past few weeks, investors around the world have been sitting at the edge of their seats waiting for a Greek debt deal.  Now that Greece has finally secured a second round of financing from the Eurozone, the apathetic reaction in the euro may have caught investors by surprise.  Up until Monday, it was still not clear whether there was enough political will in Europe to get a deal done in time for Greece to avoid a default.  However after more than 13 hours of deep discussions, Eurozone Finance Ministers agreed to a second bailout that will provide Greece with up to EUR130 billion in additional aid through 2014. The terms of the deal are also more generous than previously anticipated, which should help Greece achieve their goal of bringing their debt as a percentage of GDP ratio down to 120 percent by 2020.  This includes a higher haircut PSI (52.5% notional haircut versus 50% perviously agreed) that will bring the implied net present value loss that private investors must incur from 70 to as much as 75 percent.  Greece will also have a permanent task force in place that will monitor their progress as well as an escrow account they cannot touch.  Instead of passing their profits to individual European governments, the European Central Bank decided to forgo profits on their holdings and return those funds over to Greece.  In other words, Greece has received a much better deal than they could have hoped. 

Yet the euro gave up all its initial gains and was trading lower against the U.S. dollar by early North American trade.  In Asia, when the deal was announced, the EUR/USD soared from 1.3190 to a high just shy of 1.33.  Unfortunately once European traders digested the deal, they realized there are a still number of unknowns and areas of ongoing concern.  As a result, they took the EUR/USD lower, forcing it to give up all of its gains.  Yet it is important to put the price action into perspective. Despite the intraday volatility, in the EUR/USD the daily range so far is small and the currency pair is still trading not far from its year to date high.  This means that while investors are pleased with the Greek deal, they fear that it may not be the end of all of Greece and Europe's troubles. 

The Loose Ends

One of the reasons why the EUR/USD had such an apathetic reaction to the news was because despite the uncertainty, the resilience of the EUR/USD over the past few weeks suggests that most people expected Eurozone officials to eventually reach a deal on Greece.  The stakes were too high for them to just let Greece default.  But the real reason why the EUR/USD is not trading at 1.34 this morning is because there are still a number of loose ends that need to be tied up.  First, the IMF has not decided how much they will contribute and secondly, we still have no idea about the level of voluntary participation by private bond holders.  A credit event (or default) could still occur if Greece imposes a retroactive collective action clause (CAC) that forces all bondholders into a debt swap.  If any private bond holders decide not to participate, then a credit event could be triggered. As long as default remains a risk, the EUR/USD could have a tough time rallying. In addition, the bailout terms are strict and any missteps or deviation from program could send debt to GDP back to 160 percent by 2020.  None of the bailout terms help Greece grow and recover - they only reduce debt at the expense of growth.  Contagion remains a risk and we will be watching European credit spreads carefully to see if investors start pricing in this possibility.  Even European officials such as Schaeuble agree that the region's problems are not resolved. The Swedish Finance Minister is skeptical about Greece's ability to make necessary decisions. 

The next step is for national parliaments to approve the second bailout.  Germany will be voting on the deal Monday.  The IMF and EU are expected to determine their exact contributions by early March, which should be enough time to release funds for their March 20th payments.  

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.