Debt fears weigh on EURUSD

The euro weakened on a broad basis yesterday. Renewed debt fear was the main driver, with speculatio

(19.04.2011) The euro weakened on a broad basis yesterday. Renewed debt fear was the main driver, with speculations of a restructuring of Greek debt and fear that the True Finns could bloc the planned bail-out for Portugal in the lead. Developments in the EURUSD exchange rate, however, were partly reversed for a short period after S&P revised its credit rating outlook for the US from stable to negative.

By Maren Romstad, Analyst at DNB Markets

Yesterday was a relatively volatile day for the EURUSD exchange rate. The day started with rumors of a Greek debt restructuring. According to a Greek newspaper Greece asked about a restructuring in connection with the meeting among Euro zone finance ministers earlier this month. A source in the IMF also stated that these negotiations were expected to start in early June.

Financial markets reacted immediately by sending the euro weaker, stocks down and government bond yields in peripheral European countries higher. Greek authorities went out shortly afterwards to deny the rumors, which calmed the markets for a little while. However, this is not the first time there have been talks about restructuring the Greek government debt recently, which often can be an indication that something might actually happen.

Another factor weighing on the euro is True Finns' success in Finland. During Sunday's general election, they secured 19 per cent of the votes. The party is described as very nationalistic and EU-skeptics. The leader has repeatedly stated that they have no desire to support the bail-out for Portugal. IMF,

The European Commission and the ECB began talks yesterday on what will be the third rescue package for the euro zone. It could potentially take weeks to determine whether party leader Timo Soino poses a threat to the planned package, but most likely this is just another “bump in the road”.

At the beginning of the US session the dollar came into the spotlight after S&P revised its credit rating outlook for the US economy from stable to negative. According to the agency a downward adjustment means more than 30 per cent chance of an actual downgrade over the next two years. The reasons for the downward revision are, of course, the country's very large deficits and rising government indebtedness.

Furthermore, it may have been triggered by the last week’s disagreement about the federal budget for 2011. Republicans and Democrats are relatively far apart on several points, but most importantly they disagree on how much to cut on the budgets over the next couple of years. This time they agreed at the eleventh hour and thus prevented a shut down in the public sector. The cuts for the fiscal year of 2011 are likely to be of 38.5 billion dollars. More than what the Democrats were willing to accept, and less than the Republicans wanted.

S&P therefore believe there is a material risk that US policymakers might not reach an agreement on how they should address medium and long-term budgetary challenges by 2013. If an agreement is not reached and meaningful implementation has not begun by then, S&P would most likely downgrade the US AAA rating.

The announcement gave some market reactions. US stock markets ended the day in minus. Longer US Treasury yields rose at first, as the news could potentially reduce other countries' willingness to finance the growing deficits. However, the trend reversed fairly quickly, which may be because US Treasuries still are considered a safe alternative. In addition, the dollar depreciation was temporary and EURUSD fell yesterday from 1.44 to 1.42.

The Norwegian krone weakened against both the euro and the dollar after rumors on the possible restructuring of Greek government debt and the downgrade of US outlook. The movement against the euro might seem surprising, but is due to the krone’s relationship to risk appetite in financial markets. The Norwegian currency is small and peripheral, which are qualities investors want to avoid when uncertainty increases. We have for this reason previously argued that the krone is unsuitable as a safe haven in the currency market.

A currency which, however, for a long time has been viewed as a safe haven is the Swiss franc. In light of this characteristic the currency strengthened yesterday.