On The Dislocation Between The EUR And PIIGS Insolvency Risk

Tyler Durden's picture

SocGen provides a very informative chart on the dramatic dislocation between the EURUSD and PIIGS risk levels, as demonstrated by Greek CDS prices. Whereas in the past the two correlated very strongly, since early 2011, the pair has diverged dramatically, leading many to speculate that just like in the case of Japan, the G-7 did another coordinate intervention to push the EUR higher in 2011 at the expense of the USD and other currencies. Is it time for a "correlated" snapback? SocGen muses: "After reaching a 17-month historical high of 1.4940 last Wednesday, the EUR/USD fell towards 1.4250. The risk of a further drop cannot be excluded short term given today’s climate, even though the 1.4250 support zone appears solid (50-day moving average) and breaking through this level would open the door to a rate of 1.4000."

And some more on this curious divergence:

Regarding the euro, the current uncertainty is fuelling profit taking which had already started following a combination of very negative factors over the past days (Trichet’s less hawkish tone, correction on commodities, better-than-expected US job report). Moreover, it looks like the market has ignored this risk factor since months as it has been focused on other drivers (rate spreads, ECB tightening,…). Since January 2011, EUR/USD has spiked, and the Greek CDS also (see chart below). Such a negative correlation is very unusual and the fact that the market would focus again on this topic justifies the ongoing correction.

However, it is much too soon to talk about a trend reversal as the factors responsible for this correction are not expected to last, the European debt crisis should ease once a solution is announced and the fundamentals are expected to remain buoyant (rate spread with the US, US structural fundamentals, etc.). We keep our mid-term bullish scenario toward the 1.50 area or even above. Until then, nervousness and the risk of a further correction will remain present.

For a euro trend reversal to take place, the Fed would have to raise its rates earlier than expected, the ECB raise its rates less than expected or the Greece scenario become a catastrophe for the eurozone overall (default, poorly prepared restructuring with a strong impact on the banking sector, etc.). However, we aren’t there yet.

What does any of this means? Who knows: with central planning, it is best to just hand your cash account over to the brokerage for safekeeping, and assume 100% losses over any period of time as a guaranteed.