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Friday April 23, 2010 - 23:25:55 GMT
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U.S. Dollar Closes Week Higher Despite Volatile Euro

The U.S. Dollar finished the week higher despite volatile trading action in the Euro. The Greenback closed decisively higher against the Euro, Swiss Franc and Japanese Yen while ending up lower against the New Zealand Dollar. The Dollar ended up almost flat versus the British Pound, Australian Dollar and Canadian Dollar.


The U.S. Dollar opened the week trading higher against most major currencies except the Japanese Yen as traders sought shelter in lower yielding assets following the April 16th news that the SEC was charging Goldman Sachs with defrauding investors.


The developing situation was wreaking havoc on commodity-linked currencies since Goldman is a major player in this type of market. Traders were also taking protection against the possibility that this SEC investigation would involve other major investment banking firms. This is also coming at a time when the U.S. government is pushing hard for more financial firm restrictions. The U.K. and the E.U. were also reportedly ordering their own investigations into Goldman’s practices.


Additional pressure was coming from developing problems in Greece. Traders started the week expecting Greece to trigger the mechanism that would allow it to tap the recently approved rescue package. The week before the spread between Greek Bonds and the German Bund widened to over 400 basis points for the first time since the bailout plan was approved. This indicated that traders were nervous and concerned about Greece’s ability to survive. Others believed that the $61 billion bailout figure would not be enough to ensure Greece’s viability.


Taking a backseat to the Goldman news and Greece concerns was the possible Yuan revaluation. Traders were pressuring commodity prices on speculation China would allow the Yuan to appreciate in value. Many traders felt this move would pressure the Dollar versus the Japanese while helping to boost the U.S. Dollar against the New Zealand and Australian Currencies.


Fear that the SEC’s investigation of Goldman Sachs would indicate more financial regulation of U.S. financial markets and a reworking of the rules for foreign banks helped to pressure equities and commodities, giving the lower yielding Japanese Yen a boost. Traders who had borrowed in Yen were being forced to sell higher yielding assets to use the proceeds to pay back the loans. This triggered the weakness in the USD JPY early in the week.


With the situation in Greece continuing to unravel and the traders still sorting out the details of the Goldman law suit and its impact on the markets, traders were looking for the Dollar to be a big winner this week against most majors with the exception of the Japanese Yen. Traders seemed to be expecting both problems to escalate before they get better.


On Tuesday, although it was reported that German investor confidence improved more than forecast this month, the lingering Greece issue was expected to shift investor sentiment especially if it was combined with a slowdown in the Euro Zone recovery. Greek borrowing costs were increasing, having more than doubled at the sale of 13-week bills. This prompted Bundesbank President Axel Weber to say that Greece may need more assistance.


At this time, investors seemed to be looking for a short-term fix to a long-term problem. Hedge funds continued to press the Euro lower figuring that another call for financial aid from the European Union would begin to erode confidence in the Euro’s ability to survive. All of this news indicated that traders should continue to look to sell rallies while maintaining a bearish bias for the Euro.


By Wednesday the EUR USD continued to get pounded. Overnight the Greek 10-year Bond/German Bund Spread hit a new 12-month high at 492 basis points. Investors were asking for protection from a potential collapse in the Greek debt market. Greece was also beginning to implement some of its newly proposed austere financial measures designed to tighten up debt and improve its cash flow. Facing a huge rise in the cost to service its debt, Greece scheduled a meeting with certain European Union officials and the International Monetary Fund to discuss the terms of the recent bailout proposal.


Talk was circulating that the recent bailout plan was underfunded. Hedge funds continued to short the Euro in anticipation of more borrowing by Greece and another proposal from the EU/IMF to provide additional emergency funds if necessary.


The week-ended with Greece finally succumbing to pressure while asking the EU/IMF for help. This news triggered a short-covering rally in the Euro. The action was volatile, but the move did nothing to change the sentiment or the trend.


The week long surge in borrowing costs finally forced Greece to formally ask to tap the 45 billion Euro ($60 billion) rescue package provided by the European Union and the International Monetary Fund.


The unprecedented move by Greece threatens both the Euro’s stability and the structure of the European Union. Traders are now asking if Greece gets the money then what about Spain, Portugal and Ireland.  Many feel that these three countries are next in line for a rescue as debt problems spread across Europe. Based on current developments, the very existence of the Euro is now being questioned.


When the Euro was created a little over 11 years ago, the founding fathers gave the European Central Bank the power to control interest rates and fiscal responsibility to the individual countries. The current crisis has threatened the cohesion of the European Union as many member countries have turned their back on the sovereign debt problems of struggling member nations. These “solvent” nations are going to have to be convinced that the Euro is worth saving by ponying up the funds necessary to save the economies of the struggling members or risk debt default and the collapse of the Euro.


With the cost to service its debt sky-rocketing everyday, Greek Prime Minister George Papandreou had no choice but to ask for the money. After reaching unsustainable levels that were destroying the efforts by the Greek government to cut its budget deficit, Greece had to cave in and make the request for bailout funding. As of last night, the cost to finance 5-year Greek credit default swaps soared to 623 basis points before settling at 590 bp after the rumors of the activation of the rescue plan began to circulate.


Although the Euro rallied in a short-covering rally as news broke of the bailout, investors still have to be pessimistic about the viability of the Euro. The main concern at this time is the inability of the European Union to come up with concrete rules regarding the terms of the bailout loans. Prior to the bailout proposal put together in haste earlier in the month, the EU had no such plan. In looking-back, it looks as if that plan was not designed to strengthen the Euro, but to stem the pace of its decline.


Now that Plan A has failed, the prospects for Plan B do not look that much better as EU members appear to be making up this plan as they go along. The trick is going to be trying to convince the solvent EU members that Greece is worth saving. Furthermore, the EU member are most likely going to have to consider putting together a plan which also provides aid for Spain, Portugal and Ireland or any other nation that will need aid. The second part of the equation may be considering booting all of these struggling nations out of the club since it has already been proven that despite austere measures to shore up the budget, the capital markets are really controlling the show.


Traders and investors want clarity at this point. They want to have a fully understandable mechanism plan in place as soon as possible to prevent the collapse of the Euro. If history gives us any clues, however, the EU will drag its feet and fail to live up to its responsibility as a partner. Germany especially will be the biggest hurdle for Greece and the other sovereign nations to overcome. Not only are the Germans against any kind of bailout plan, but the Greek citizens feel that a bailout will make them appear weak to the global community. This means that eventually the next bailout plan will fall squarely in the hands of the International Monetary Fund.


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