Eurozone banks will prove the downfall of the single currency
AFTER months of Europe scoffing at the troubles of the Anglo-Saxon banking system, it appears likely that many Eurozone banks have plenty of skeletons in their own closets.
The European Central Bank (ECB) said earlier this week in its Financial Stability Review that it estimated Eurozone bank writedowns due to securities – or toxic assets – would total around $218bn while bad loans would account for another $431bn.
These forecasts are much lower than those from the International Monetary Fund (IMF), which estimates that Eurozone banking writedowns could total $750bn, so things could be worse than the ECB is anticipating.
On the same day as the ECB’s figures Moody’s, the ratings agency, cut the senior ratings of 25 Spanish banks, citing expectations of further capital pressures and Banco Santander is still under review for a possible downgrade.
The currency markets have been worried for much of the past six months over European banks’ exposure to Central and East European (CEE) loans and the recent worries that Latvia could default on its loans have only intensified these concerns.
The ECB has noted that individual bank losses from emerging markets could be up to one-third of their Tier One capital.
The single currency has held up during the return of risk appetite to the markets, but analysts are concerned about how long the euro can continue to ignore the bloc’s problems.
EVEN KEEL
John Hardy, FX strategist at Saxo Bank, says: “We hardly think the euro can maintain an even keel for the long haul. The market could lose faith in the single currency if it stops to take stock of where the currency should be trading in light of the Eurozone’s own special problems – the desperate straits of the weaker Eurozone members and the insufficiently addressed holes on European banks’ balance sheets on domestic and CEE asset play exposures.”
The Eurozone banking sector’s problems are making it difficult for the affected banks to raise sufficient capital, which is in turn having an impact on European banks’ ability to lend.
FX strategists at French bank BNP Paribas say that credit will remain tight and the sharp and accelerating decline of monetary supply (M3) growth rates in the Eurozone suggests that weak bank balance sheets and their impact on the European economy will be the thing to watch when trading the euro in the second half of this year.
They add: “Although we would still not rule out a renewed move higher toward the 1.45 area for euro-US dollar ahead of the German elections in September, we would view such gains as providing a renewed selling opportunity. Near-term, the break below the 1.3795 level implies a corrective pullback into the 1.36/1.3580 area. Any break below here would suggest a more immediate move lower.”
RISKY ASSETS
Although it is agreed that the dollar is not a pretty story, the general consensus is that the Eurozone has yet to realise the pain of bank writedowns that the US experienced at the end of 2008 and early 2009.
The true scale of European banks’ exposure to risky assets is likely to be revealed over the next 12 months and we shall start to see a sell off in the euro.
It is best to play euro weakness by selling the euro against the US dollar because the greenback’s safe-haven status will be beneficial if and when we see the widely expected correction in equity markets and a return of risk aversion. The woes of the Eurozone and its banking sector will only serve to amplify the movement lower in euro-dollar, making it a profitable pair to sell right now.