Euro Crisis Complacency May Collapse with 1Q GDP Data

Fundamental Forecast for Euro: Bearish

• ECB Economic outlook sours, 2013 GDP forecast 0.4 percent contraction

• Spain and Portugal report record unemployment rates

• A bigger EURUSD move ahead?

Though EURUSD took a tumble this past week – largely on the incredible strength of the US dollar – the Euro individually performed well through the period. That vigor may not hold next week though as risk appetite trembles and first quarter GDP figures reflect on the region’s economic troubles. By few measures outside of a desperate hunt for yield does the world’s second most used currency present a strong front. The inherent risk for the region’s economy and financial system is a constant threat. New rescue efforts are still not complete and established programs are straining the region’s fragile stability. The ECB is once again (late) jumping back into the stimulus game. And, the seemingly unflappable sense of investor confidence is hitting sincere limits. In a game of probabilities, there are fewer and fewer avenues of support to maintain this troubled currency’s immunity.

Before we head down the road of harsh and inescapable reality that the euro faces moving forward, we should first speak to the currency’s strengths – of which there are few. In recent months we have seen an environment where investors have shown a panicked need for return that they are not finding in traditional assets. That has led to an influx of demand for depressed markets and assets that have good reason for a high yield. We have seen this appetite clearly in both ‘junk’ rated corporate bonds as well as periphery (Greece, Cyprus, Portugal, Ireland, Spain, etc) sovereign debt and assets. In a world where the perception is that no troubled asset will see a liquidity crunch, this is a reasonable pursuit. Yet, such complacency is unrealistic even in markets that have heavy central bank support.

Continuing with yield, FX traders should recall that less than two weeks ago, the European Central Bank (ECB) cut the region’s benchmark rate by 25 basis points to 0.50 percent. While the market rates (like Euribor and deposit rates) were already decimated by the LTRO programs, this benchmark generated a sense that there was a premium return in holding the euro. With the cut, any hold out belief that there was ‘carry’ with the euro is crushed. This is further problematic when the ECB’s primary counterparts are already at the bottom of the yield spectrum, and the markets have already acclimated to the fact. Furthermore, there is a concern that the monetary policy effort to deflate the currency may not stop at rates. The possibility of buying Asset-backed Securities (ABS) has been floated as a means to direct capital to small and medium-size businesses that need it the most. That is very much like the Fed’s MBS push with QE3…