Euro Parity Risk Against Dollar Remains High as Germany, France Risk Ratings Cut

Includes: ERO, EU, FXE, UDN, UUP
by: Ophir Chador

Standing behind the debt of troubled EU member states may jeopardize Germany and France's AAA credit rating, according to UniCredit. The longer term outlook for the EUR/USD remains decidedly negative, with increasing potential for parity in the months ahead.

Stefan Kolek, a strategist at UniCredit, warns that the bailout package is “making debt profiles deteriorate, potentially damaging the ratings of core sovereigns. It’s a kind of Ponzi game at the highest level.”

Meanwhile, the question of moral hazard in the face of the unprecedented bailout -- unprecedented for the EU, that is -- continues to follow the European Central Bank, which only yesterday proclaimed that it remains "fiercely" independent.

According to Jim Reid, chief fundamental strategist at Deutsche Bank, the bailout package adds "exponentially" to the issue of moral hazard. He adds that the plan “is not particularly pro-growth [and may] be looked back on as a landmark day for the ECB. Their total independence may now be increasingly questioned.”

At this point, growth concerns in the eurozone have yet to be addressed at all. Indeed, the bailout package in no way addresses growth, instead focusing entirely on averting immediate defaults by EU member states. However, in some cases, default is the best solution. Greece, for example, has little hope for growth in the years ahead, which will amplify the burden of its mounting debt. Meanwhile, Greek austerity measures will only worsen the economic outlook for the country, making repayment of longer term debt -- absent subsequent aid -- extremely unlikely.

The EUR/USD remains a very attractive short candidate going forward and has operated as expected so far this week. As noted in the weekly playbook:

For the EUR/USD ... the 1.30 handle will likely prove a stubborn point of resistance going forward. (An upward break of the 1.30 mark in the short-term is likely to reverse shortly thereafter.) The Asia open should provide some clues as to market bias for the days ahead. However, do not be fooled by an immediate rally, which may quickly give way to further declines.

At this point, the potential for EUR/USD parity remains extremely high in the longer term.

Disclosure: Author is short EUR/USD