BAD as things seem for the eurozone, the value of the euro does not suggest investors are betting Europe’s currency bloc will fall apart.
Even in the wake of its recent slide, the euro at $1.30 is far from levels that would reflect fear of a break-up.
A look at the euro’s history suggests the currency is not yet in a danger zone.
Since its inception at $1.17 in 1999, the euro has traded between $0.82 and $1.60.
The current price around $1.30 is well above the mid point of its historic range. The average level is about $1.20.
That does not mean the euro’s current rate is a resounding vote of confidence. It's just that many believe the costs of a split would be so high that Europe’s leaders will pay any price to prevent it – even the European Central Bank (ECB), which so far has been reluctant to support troubled euro debt markets.
Jens Nordvig, a currency analyst at Nomura Holdings, said the ECB would eventually take the decision to provide more support, “probably towards the end of the first quarter.”
Investors see the euro heading lower. Deutsche Bank sees it at $1.25 by the first half of 2012 and Nomura’s forecast is for $1.20 by the second quarter.
Recent data shows short positions among futures traders aren’t far from record highs.
Hedge fund manager John Taylor, chairman and chief investment officer of FX Concepts, said the euro’s resilience of recent months is due to deleveraging by eurozone banks as they sell foreign assets and repatriate the funds back into euros. He predicted a year ago that the euro would fall to parity against the dollar, and is now more convinced it will happen. What complicates valuing the euro, even in a break-up, is that some nations would have a stronger currency on their own.
Mr Taylor said: “The euro is a schizophrenic currency. If it were northern Europe, the euro would be worth $1.80 to $2 against the dollar. If it were southern Europe, it’s worth 80 cents to $1.”
One thing that would hurt the euro, at least in the short term, is a messy default and eurozone exit by Greece.
On its own, a Greek default is probably manageable given Greece accounts for only 2.2% of eurozone GDP and 4% of the public debt, said Willem Buiter, Citigroup chief economist and former Bank of England policymaker.
“However, a disorderly sovereign default and euro area exit by Italy would bring down much of the European banking sector,” said Mr Buiter.
Indeed, many see Italy key to keeping the current crisis from turning into chaos, and thus holding the euro together.
The flashpoint here could be Italy’s bond market. Bond investors generally have appeared more worried about the eurozone’s survival. Bid-ask spreads in the Italian bond market widened out in November as credit risk rose, a sign that regular buyers were leaving that market.
Rising government bond yields for Greece, Portugal and Ireland forced them to seek international bailouts. The ECB has so far resisted calls to provide massive support for the Italian bond market, even though yields have risen above 7%, a level many see as unsustainable.
As the eurozone’s third largest economy, some say it would be unthinkable for Italy to sink. A meltdown in its bond market could force the ECB to buy aggressively to save the eurozone.
