The continuing Eurozone debt woes and the Euro - Outside View by Asad Dossani

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The continuing Eurozone debt woes and the Euro
Mar 28, 2011

Two important events occurred this week that concern the Eurozone and its continued debt troubles. First, Portugal's debt was again downgraded by Standard & Poor, this time from A- to BBB. Second, European leaders have agreed new plans for a bail out fund to help indebted countries.

Portugal has had numerous political problems when it comes to implementation of austerity measures. The prime minister resigned earlier after the government did not pass through austerity measures required to bring down the deficit and debt levels. Markets are increasingly worried that Portugal lacks the political will to see through reforms, and this has led to the ratings downgrade. Yields on Portuguese government bonds have also gone up in response to this.

The new European bail out fund has also been filled with political troubles. Namely, there has been much negotiation over the amount each country would be required to put into a bail out fund. This is the case as most countries are going through their own austerity measures, and there is little public support to use funds to bail out other countries.

Despite the fact that Portugal may be close to a bail out, that debt problems seem to be spreading, the euro has continued to perform well. Against the dollar, the euro is trading above 1.40 for the first time since last November and before that the euro was at 1.40 last January. Against the rupee as well, the euro is near its all time highs. Doesn't it seem strange that the Euro is around the same level it was in January 2010 before all the debt troubles began? Many investors would have assumed in January 2010 that if a debt crisis were going to occur over the next year, the value of the euro would surely fall over that time. So why has it done so well?

The main reason is Germany. The German economy has proved to be very resilient throughout this whole crisis, and their strong economic performance has kept the value of the euro up. France's economic performance has also been strong, though not to the same extent as Germany's.

The other reason the euro has performed well is that the US dollar has performed poorly. The euro-dollar is the most widely traded currency pair and so it is very uncommon for both the euro and dollar to move in the same direction. Thus, the weaker US dollar due in part to quantitative easing polices by the Fed has helped to keep the euro strong.

The Eurozone debt crisis certainly has come way to play out. Portugal is likely to need a bailout at some point in the future, and countries like Spain continue to be on the radar for many investors. The euro has held its ground well so far, but there is no guarantee this will continue going forward.

Disclosure: I do not hold the currency/commodity discussed in this report.

Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!

Disclaimer:

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