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Greece Overrides Euro Fundamentals

The future of Greece and the European Monetary Union is currently unknown and this makes for difficult trading in the

The European economy and the euro currency have been greatly affected by Greece’s debt crisis for the past several months. On July 5 a referendum was held asking the people of Greece whether they accepted the recent proposal by the Troika creditors. The “no” vote won with a 61% majority.

This refusal to accept terms of the creditors’ proposal has led to great uncertainty for the future of Greece and Europe. The euro gapped lower on Monday, July 6th – just as it did the prior weekend when the Tsipras government rejected the proposal and called for a referendum.

Talks between Greece and Eurogroup creditors are due to resume, however in the post-referendum environment outcomes are difficult to predict. Greece still has billions of euros worth of payments due in the coming weeks which they cannot service unless their aid is extended or debt restructured.

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What the Numbers Say

On Tuesday, June 2, CPI from the Euro-zone showed the first positive reading since November 2014. Annual inflation was at 0.3% while the core reading, which excludes food and energy prices, was at 0.9%. This was an important development for the Euro-zone as it implied that the ECB’s massive quantitative easing program was beginning to have its desired effect.

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However the following month reading, for the 12 months ending June 30, showed the inflation drop back to 0.2% and the core reading 0.8%. Provided that annual inflation remains above zero then the ECB will be of the view that the current QE program is having positive effects. The latest ECB forecasts show inflation at 0.3% in 2015, 1.5% in 2016, and 1.8% in 2017. Meanwhile, growth is expected to hit 1.5% this year, before rising to 1.9% in 2016 and 2% in 2017.

Strength Factors

From mid-March to mid-June we saw the euro in a general uptrend, despite its bearish underlying fundamentals. This spate of strength can be attributed to a numbers of factors:
1. The euro had depreciated significantly across the board during the second half of 2014 until the end of Q1 2015. The EUR/USD fell 3,500 pips during a 10-month period. The new price of the euro is now closer to its fair value.
2. As inflation ticked up during the second quarter of 2015, some market participants were prompted to take profit on trades that were placed ahead of the ECB’s bond-buying program. Traders had entered the following positions during 2014 and early 2015: long European equities, long European bonds and short euros. A reversal of these positions saw euro strengthen, not only due to liquidation of speculative euro shorts but also an unwind of euro hedges executed by foreign investors who bought into EU stocks and bonds. Bunds yields rallied alongside the euro as evidence of this association.
3. A rebalancing of a heavily short euro market amplified any run higher as stop losses were hit on occasions.
4. Poor Q1 growth from the US helped EUR/USD rally.

Going Forward

We have witnessed unpredictable volatility in the euro since late May when the Greek situation escalated. The future of Greece and the European Monetary Union is currently unknown and this makes for difficult trading in the currency.

The underlying fundamentals are still extremely bearish due to the ECB’s ultra-loose monetary policy. However, news regarding Greece will completely override this in the short-term and sentiment can change in a flash.

We maintain our bearish bias but advise avoiding trading in the euro for now, at least until there is more certainty regarding Greece’s membership within the currency.

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