Seeking Alpha
Currencies, event-driven, debt, portfolio strategy
Profile| Send Message| ()  

When is the last time the markets have heard anything bullish about the euro? The perils of the single currency, the sovereign debt crises, the underfunded European banks, the lack of a lender of last resort, and repeated stories Greece is about to leave the euro, are all repeated and embellished by the bears.

We, too, have been have been euro bears for a lengthy period, but have we gotten to the point where the bulls have capitulated, and the bears have doubled down on their positions? Granted currency markets are usually trending markets. and often they last a long time. Despite the perils of picking a reversal, we think there are some reasons for the bears to be cautious.

To begin, the bear side of the market has become very popular. The latest COT Report showed in the futures and delta adjusted option positions, the speculative bears had increased their short position to 219,642 contracts, a recent record. Speculators also have an expanding short in the Swiss Franc. Since the SNB pegs the SF to the euro, the large short in the SF is really a proxy for a short euro. The open interest in the SF is much smaller than the euro, but the specs are short 93.7% of the OI in that market. So far, the bears have the money, but with so many on one side of the market, what would happen if the sentiment shifted.

There have recently been conflicting rumors about the next move in the Greek saga. Recently CNBC reported, Lucas Papademos, former Greek PM said there were preparations being made in Greece to exit from the euro and return to the drachma. Later, Papademos denied he knew anything specific but the initial statement was given as a reason for the equity sell off, and the break in the euro versus the USD recently.

The repeated rumors have speed the flight of capital from Greece. There are reports of a pick up of wealthy Greeks shopping for London real estate. Concern for safety has caused a big demand for the German two year paper where the yield is down to .06%.

While the flight of money from Greece may have caused a liquidity crisis, the Financial Times yesterday reported: "Secret Central Bank Aid Props Up Greek Banks"

"There has been no official announcement. No terms or conditions have been disclosed. But Greece's banking system is being propped up by an estimated €100 billion or so of emergency liquidity provided by the country's central bank - approved secretly by the European Central Bank in Frankfurt ... Extensive use of 'emergency liquidity assistance' (ELA) to help banks in the weakest economies has been one of the less-noticed features of the eurozone crisis."

If the departure from the eurozone were imminent, why would the ECB really be providing support to the illiquid Greek banks?

There are others that claim Greece will voluntarily drop from the eurozone. To implement such a plan the Greeks would need secrecy and assertive leadership. Without secrecy the capital flight from Greece would deplete all savings and cause chaos. To adequately prepare for departure from the euro and a return to the drachma, the borders would need to be sealed to stop capital flight, electronic transfers need be stopped, a new currency has to be printed, and existing contracts would need to be modified. Currently there is no effective leadership in Greece, so how can any of this happen?

Perhaps leadership will emerge from the June 17th election, but it is reported the Greeks will run out of money within six weeks. The only supply of funds will be from the IMF and the EU. Recent elections have not been kind to the austerity proponents, but perhaps the current hard line taken by Germany will cause the Greek voters to reconsider their votes for the next election.

The European politicians have recently been on a whirlwind tour. First there was a G-8 Meeting at Camp David, near Washington. This was followed by a NATO meeting in Chicago. With the November U.S. election rapidly approaching we can assume President Obama was busy trying to get Chancellor Merkel to lighten up on the austerity plans. The last thing he wants is a further European economic slowdown.

Tonight is the final meeting, this week, for the busy European politicians. They are meeting in Brussels where the new French President Hollande claims he will petition Merkel to approve Euro Bonds and relax her austerity standards. Markets are likely to be extremely sensitive to reports coming from these meetings. European politics remain the driver of the EURUSD pair.

Not every one looks for a bearish outcome to the German Greek impasse. Historian Niall Ferguson had these comments in the London Sunday Times:

"Ferguson's broad view, then, is clear: disintegration is what should be feared and what should be avoided. But look where we stand at the moment. On the one side is a seemingly immovable Germany sticking resolutely to the austerity script. Those countries who borrowed and spent with cheerful southern European abandon when the times were good must now pay the price, Berlin says.

"It is still possible that the game of chicken between Athens and Berlin ends with the two cars colliding," Ferguson says. "But my sense is that both will swerve at the last minute - the Greeks because they see the costs of exit would be catastrophic for them, and the Germans because - if they don't realise it already, they pretty soon will - the banking crisis that this would unleash as deposits fled the periphery would be highly destabilising for the whole eurozone, Germany included.

"The Greeks say, 'We're not going to comply with our commitments'. The Germans say, 'Then you're out'. They're both bluffing." And so, he argues, Germany - through gritted teeth - will have to concede that Europe as a whole must stand behind the debts of individual nations. Welcome to the era of the eurobond."

The European debt mess continues to evolve, and perhaps there is a lot more to the down side, but the trade is lined up very short. A bullish surprise might jolt the market.

Have the Bears Taken the Euro Low Enough?
(Click to enlarge)

Have the Bears Taken the Euro Low Enough?
(Click to enlarge)

Source: Have The Bears Taken The Euro Low Enough?