Currencies and the Greek Debt Crisis

by: Daryl Montgomery

The spread between Greek government bonds and their German equivalent hit a new record high yesterday (April 8th) as new worries of a possible Greek debt default emerged. EU central bank president, Jean-Claude Trichet, promptly moved to calm the markets by stating that Greece is in no danger of default and it does not require a bailout. While we have heard it all before, Trichet's remarks kept the euro from hitting a new low against the U.S. dollar and this may indicate that a temporary bottom is in place.

The latest phase of the seemingly never-ending financial crisis in Greece took place as the ECB (European Central Bank) and BOE (Bank of England) had their rate-setting meetings. Both left interest rates unchanged. The ECB kept its rate at 1.0% for the eleventh month in a row and the BOE kept its rate at a historically low 0.5%. The BOE also kept its quantitative easing target at $200 billion pounds (the figure has been raised a few times) and stated it was optimistic about low inflation going forward. The market seemed somewhat less hopeful with the pound falling below 1.54 per U.S. dollar.

Despite choppy trading in the pound, it did not test its March lows, which had last been seen ten months previously. The euro fell as low as 132.80 against the dollar, slightly above its low in late March of 132.67. The euro's inability to hit a new low on the latest flare up of problems in Greece is bullish for the currency and indicates a bottom may have been put in. Along with the euro and the British pound, the Swiss franc also did not take out its March low. The Greek crisis has caused money to flow out of the Europe in general, not just the eurozone and this may have come to an end - at least for the moment.

The money that flowed out of Europe went to North America first and this has been bullish for both the U.S. and Canadian dollar. The Canadian dollar has not only risen against major European currencies, but has almost hit parity with the U.S. dollar. The Australian dollar has also held up well and has been rallying since early February. Market attention is now turning to China with reports that it might revalue its currency upward 3%.

While it looks like we have seen the crisis low in the euro, we have yet to see the final resolution of problems in Greece. The market seems confident that that will occur soon. Resolving the problems with Greek debt is in and of itself not that difficult. Greece represents only 2% of the eurozone economy. What happens with Greece will set a precedent with how debt problems in other eurozone countries will be handled, however. Sooner or later the EU will have to do something about Portugal, Ireland, Spain and Italy, the other potential trouble spots in the eurozone. How the market reacts to this remains to be seen.

ETFs/ETNs for the currencies mentioned in this article are FXA, FXB, FXC, FXF, DXY, and CYB and CNY, representing the Australian dollar, the British pound, the Canadian dollar, the Swiss franc, the U.S. dollar and the Chinese renimbi, respectively.

Disclosure: None