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Euro Extends Plunge as Rumors of Greece Abandoning the Currency Circulate

Euro Extends Plunge as Rumors of Greece Abandoning the Currency Circulate

2011-05-06 17:46:00
John Kicklighter, Chief Currency Strategist
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There has been no shortage of speculation surrounding the various troubles for the European Union; but until recently the speculative markets have been willing to overlook conjecture in order to focus on higher potential returns. Heading into the close of this trading week, however, we can see that the balance between risk and reward is rebalancing. Following the ECB’s effort to curb aggressive yield forecasts with its policy decision and press conference yesterday; we now find the market circulating alarming rumors that Greece is threatening an exit from the euro. Is this likely; and what would the impact on the euro be?

In terms of rumor mongering and speculation, the Der Spiegel (one of Germany’s largest news magazines) report doesn’t exactly push us into new territory. Over the past weeks, we have seen speculative reports that Greece would soon be restructuring its debt, that a real estate-driven financial collapse for Spain was imminent, that Ireland was contemplating abandoning the euro if the new government wasn’t granted accommodation on its emergency lending rates and that Ireland and Portugal were on the verge of asking for bailouts among other stories. Obviously, not all of these concerns were fluff as we have actually seen Ireland and Portugal seek their now contentious bailouts. That should remind us that we should not simply write off this article’s claim that German government officials have warned that Greece is threatening an exit from the Monetary Union – especially if the market is paying attention.

Looking at the commentary we have seen this morning, it is not surprising to see quick denials from the most important groups. German government spokesman Steffen Seibert, spokesman for French Finance Minister Christine Lagarde and the Greek Finance Ministry itself were the fastest to reject speculation. From an official’s standpoint, if Greece were to in fact exit the euro; it would benefit both parties to deny speculation to maintain stable markets. Greece would not want to see its sovereign yields surge; which would be a likely outcome as the market would interpret the move as the government loosing access to EU/IMF funds and an effort to return to the country’s dramatic monetary policy changes of the past (devaluing its currency, allowing deficits to balloon, etc). For the European Union, an exit of one member would open the door to other countries that are under tremendous pain to meet the group’s financial criteria (especially those like Portugal and Ireland who have governments that have been put in place by citizens that are weary of EU rules).

Until there is an official announcement that Greece is bowing out, skepticism of such an occurrence will be extremely high. However, the fallout from such a move is so great that the market cannot afford to ignore it. The impact on the euro would be tremendous. Some may consider this a purging of a weak performer; but in reality, it would be a signal that the monetary union is not as solid as has been advertized over the past decade. And, if members can just check out of the currency; then how practical is it to treat the euro as an alternative reserve currency to the US dollar (the primary catalyst for the former’s gains over the past decade). If indeed there is truth to these claims, we can see a principal fundamental driver for the euro crumple and a major market shift take place.

Pending the substantiation of this speculation, the euro will remain under pressure; but it will also hold off from a major run. The fact that there is an unscheduled gathering of EU finance ministers tonight – though they say it is unlikely to be about Greece’s euro exit – is simply too suspicious. This is adding to the euro’s current pressure. Should we see confirmation that the country intends to leave the constraints of the cooperative (with the necessary spin), we’d expect to see the euro plummet. Alternatively, putting to rest this speculation could lead to a temporary bounce that unwinds this morning’s losses. However, that doesn’t mean that it will recover any more ground than that; as traders now realize that the market is highly sensitive to concerns over the region’s financial stability. For EURUSD, we are just breaking the rising trend channel that has carried the pair high since the beginning of the year. And, considering the dollar is the euro’s primary counterpart; and capital has long flowed from the former to the latter for diversification, the move could be a long-term trend. EURCHF and EURJPY could see important safe haven flows way from the euro as investors unwind carry (to the yen) and simply seek stability (in the franc).

Euro_Extends_Plunge_as_Rumors_of_Greece_Abondoning_the_Currency_Circulate_body_Picture_3.png, Euro Extends Plunge as Rumors of Greece Abandoning the Currency Circulate

Charts Generated using Intellicharts

Euro_Extends_Plunge_as_Rumors_of_Greece_Abondoning_the_Currency_Circulate_body_Picture_4.png, Euro Extends Plunge as Rumors of Greece Abandoning the Currency Circulate

Charts Generated using Intellicharts

Euro_Extends_Plunge_as_Rumors_of_Greece_Abondoning_the_Currency_Circulate_body_Picture_5.png, Euro Extends Plunge as Rumors of Greece Abandoning the Currency Circulate

Charts Generated using Intellicharts

Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

To receive John’s reports via email or to submit Questions or Comments about an article; email jkicklighter@dailyfx.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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