Tuesday, 10 May 2011

Greek Debt Crisis and ECB Interest Rates Driving the Euro

The euro continues to tread water as the common currency has come off its recent lows but still trading inside yesterday's range versus the major currencies. Fears of a Greek restructuring and even threats of succession from the euro zone have pushed the euro to its lowest level in 3-weeks. However, traders should keep in mind that the underlying factors driving the euro's previous gains have not changed.

New rumblings from Greece caused an emergency meeting of the EU financial heads this past Friday. The not so secretive euro summit identifies the headline risk for the euro as talk of Greece leaving the euro zone compounds the difficulties EU finance minsters face. New measures will need to be taken in order to dissipate market fears of a Greek restructuring but at this time it is unclear what approach the EU will take.

The Financial Times noted in comments from a Greek official, one possibility may be for Greece to sell bonds to an EU bail-out fund, or extend the maturities on its existing debt. Any talk of a restructuring, which is simply a nice word for a default has been staunchly denied by EU and ECB officials.

Interestingly enough, the Financial Times also noted the first public mention of Greece's inability to return to the market next year to support its funding needs. This should be taken as a significant point in the ongoing crisis as it displays the failure of the measures taken by European leaders to solve the Greek debt crisis. This renewed flair up combined with last week's lack of “Strong vigilance” from ECB President Trichet has dropped the euro and kept the EUR/USD range bound this week.

The Greek debt crisis has reemerged to one of the factors contributing to the recent decline in the 17-nation currency, but as was the case from January to May when the euro put in an astounding performance the Greek debt issue may be once again put on the sideline and continue to be temporary issue in the FX markets.

Traders should keep in mind that the underlying factors driving the euro's previous gains have not changed. The Federal Reserves is not expected to raise interest rates until mid-2012 while the ECB is forecasted to increase rates another 25 bps in July. The interest rate differential between Europe and the US should continue to support the euro. Today the spread between the 2-year German Bund and the 2-year US Treasury stands at 115.9 and should continue to rise, highlighting traders focus on yield and supporting the euro in turn.