EURO-SWISSIE OFFERS THE CLUE TO RISK
LAST week, European Central Bank (ECB) chief Jean-Claude Trichet uttered the fateful phrase, “strong vigilance”, signalling that the central bank would hike rates by 25 basis points in July, to 1.50 per cent. However, instead of rallying, the euro-dollar promptly fell four big figures in the wake of the announcement. Part of the reason for the selloff was attributed to the classic “buy the rumour, sell the news” dynamic which is so common to speculative markets. Furthermore, after Trichet lowered the ECB’s inflation projections for 2012, some of the decline was due to the concern that the move in July will be a one-off affair rather than the start of a series of rate hikes.
Ultimately however, it was the change in markets’ focus that was the main driver of the euro decline. As the interest rate differential story began to move off centre stage, attention turned back to the Greek sovereign debt problems and the ongoing dispute between the German finance minister Wolfgang Schaeuble and Trichet regarding the terms of the second bailout. Schaeuble said last week that private investors should be asked to extend the maturities on their Greek bonds for seven years, a move that credit rating companies have termed to be a default. Trichet said any approach that risked a “credit event” would be an “enormous mistake” for the euro region, because of the possible contagion effects: many French and German banks would be forced to write down their positions, greatly reducing their capital base.
Despite the wrangling between the ECB and German fiscal officials, a broad consensus is developing that Greece cannot be allowed to default given the risks that such an event could trigger within the European financial system. Therefore, the market remains relatively complacent at the moment and euro-dollar has managed to rebound at the start of the week. Nevertheless, traders are carefully watching the SFr1.20 level in euro-Swissie as the key barometer of risk flows this week. If the pair breaches that barrier, it would be a sign that the Greek sovereign debt problem may spin out of control.