The market’s "discovery" of such heavy debt and the self-swallowing nature of the EFSM resulted in the kind of sudden shift to long-known but ignored information that has defined the relationship between the dollar and euro since the credit crisis hit in earnest — even as both currencies have slid sustainably against the Swiss franc (see "The dollar-euro-franc triangle," below). It is likely to underlie trading in all markets for the foreseeable future.
"There are so many wildcards in this market now and also so many well-recognized problems that the market only seems to focus on one thing at a time, and traders will do best by just figuring out that week’s focus," says Jessica Hoversen, a foreign exchange and fixed income analyst at MF Global in New York. "It’s an odd market, and one that seems incapable of multitasking."
It’s also the kind of market that keeps David Hiscock up at night. As deputy head of regulatory policy and market practice for the International Capital Market Association (ICMA), he’s one of the people tasked with keeping an eye out for new systemic risks, and he believes current capital requirements have created one of head-swallowing proportions.
More specifically, he’s concerned about capital-requirement rules that focus on liquidity buffers, which are the liquid assets that banks have to keep on hand for disasters. Generally speaking, those buffers are supposed to be comprised of sovereign debt because sovereign debt is something that is both safe and easy to sell in a pinch.
"This works well if one bank is having a problem, and the problem is related to the bank," he says. "But what if the banking system itself is having a problem, and the banks’ sovereign has assumed risk on their behalf, which drives down the value of the sovereign debt, which forces the banks to take losses on the paper of the sovereign debt that they are forced to hold…?"