Market Overview

Ireland Is Junk, Euro Still Higher

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The euro recovered some of its recent losses on Wednesday, in spite of Ireland being downgraded to junk by Moody's. At the moment, the euro added 0.82% to its value against the U.S. dollar to trade around $1.4091. At the same time, the euro surged against the Japanese yen as well. Currently, the euro is trading around ¥111.65, up 0.84%.

The big question is where do traders find optimism about the troubled European currency? The focus of investors quickly shifted from Italy to Ireland on Wednesday, as Moody's downgraded Ireland to junk. In fact, it seems incredible how investors can follow all the debt problems in the Eurozone. A week ago it was all about Greece, yesterday it was Italy, today it is Ireland. Every day a new country it seems.

Ireland, only a shadow of once mighty Celtic Tiger, has been the second Eurozone member to ask for a bailout, right after Greece. Ireland's bond spread over Germany has been growing ever since. The recent downgrade will probably push the costs of borrowing for the Irish Republic even higher. It remains to be seen if the costs of borrowing will go so high as to force Ireland to ask for another bailout from the EU and the IMF.

This would be a repetition of the Greek scenario. Following the first bailout, investors remained worried about Greece's ability to repay its debt, which forced the costs of borrowing so high Greece was unable to take new loans on open markets. Finally, it was forced to turn to the EU and the IMF for help once more.

In the meantime, the IMF is urging Italy to step up its austerity measures in order to bring back its budget deficit and public debt under control. The IMF warned the Italian government its growth rate projections might be a bit too optimistic. Under the current plan, Italy plans to slash €48 billion in public spending over three years, eliminating its budget deficit by 2014. If Italy's growth falls below the government's expectations, more cuts will be needed since the government's tax revenues will be lower.

It is becoming more evident that Italy's fate no longer lies only in the hands of its government. Even if the Berlusconi government embarks on an ambitious plan of spending cuts, it remains to be seen if the Italians can stomach these cuts, the country might be forced to ask for a bailout or even declare bankruptcy if the situation in Greece, Ireland and Portugal deteriorates even further. Unfortunately for the Europeans, there is more evidence each day that suggests that the only real question in the Eurozone debt crisis is what will be the route of the domino effect. If Greece declares (partial) default or better when Greece declares it, will Portugal or Ireland be next? Which giant will fall first, Italy or Spain?

If bankruptcy epidemic does strike the Eurozone, a part of the blame will fall on the ECB. The latest inflation data again suggest inflationary pressures are easing without the interest rate hike. Germany's wholesale price index declined by 0.6% in June, compared to a month earlier. At the same time, Spanish CPI decreased from 3.5% in May to 3.2% in June. Both sets of data were below analysts' expectations.

Earlier this month, the ECB decided to raise its interest rates to 1.5% in order to stem inflation in the Eurozone center. The inflation data published since the ECB decision pretty much point to a conclusion that inflation would go down on its own. By raising interest rates, the ECB made life a bit more difficult for the Eurozone periphery, however, as already high costs of borrowing rose even higher. It seems the interest rate hike decision was a mistake and the peripheral economies are likely to pay the largest chunk of the bill.

ACTION ITEMS:

Bullish:
Traders who believe that there are just too many loopholes in the Eurozone defenses, which will ultimately force the Europeans to let some of the Eurozone members to bankrupt, moving the euro into a state of freefall, might want to consider the following trades:

  • Market Vectors Double Short Euro ETN (NYSE: DRR) is a short play on the euro. DRR will rise if the euro depreciates.
  • ETFS Short Euro Long US Dollar ETC ETF (SEUR) is another short play on the euro. SEUR will rise by less than DRR, however, should the euro depreciate.

Bearish:
Traders who believe that the Europeans have shown determination to resolve the debt crisis on the Eurozone periphery without defaults and that persistency will ultimately pay off, which should provide some tailwind for the euro, may consider an alternate positions:

  • EUR/USD Exchange Rate ETN (NYSE: ERO) is a long play on the euro. ERO should rise if the euro appreciates.
  • ProShares Ultra Euro ETF (NYSE: ULE) is another long play on the euro. ULE should rise more than ERO, however, should the euro appreciate.

Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

 

Related Articles (DRR + ERO)

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