In a carry trade you want to sell a low-yielding currency and buy a higher yielding currency, Chandler says. “So for countries like Germany, what that suggests is that the euro can be a carry trade. One could sell the euro and buy a higher yielding currency like the Australian dollar, New Zealand dollar or Canadian dollar (see “Carry opportunities,” right). And that’s in many ways what has happened.”
Ultimately, the situation for the euro is a crisis primarily of confidence, says Ilya Spivak, currency strategist for DailyFX, the research unit of FXCM Inc. “It’s not so much that people are afraid that a country like Greece, Italy or Spain will default, the danger is that nobody has any idea what that default would look like.”
Spivak says that if anybody had a clear base line for pricing what the worst case scenario likely would be, the markets would reflect that and move on. “But here you don’t have any kind of clear precedent for what the end-game is. So, as you continue to face uncertainty, you’re going to continue to face downward pressure on the euro as people basically say ‘I just have no idea what is going on here,’” he says.
Spivak notes that there is no legislative framework for a country to get out of the Eurozone, and there is no concept of what it means for a country inside a currency union to default when certain other members — notably Germany — are very sound. “It’s very difficult to say what the worst case scenario is because the markets have a hard time actually pricing assets based on this,” he says.
The main beneficiary of the euro’s problems continues to be the U.S. dollar. “It’s not so much a vote of confidence in the U.S. economy as a flight out of the various risks, notably Europe. But that still tells you to what extent people would rather let the U.S. Treasury hold onto their money than almost anything else,” Spivak says.
Chandler adds, “The dollar is in a bull trend or a rising cycle, which probably still has a bit more time to run. It just so happens that there are uglier sisters at the ball. If I were to bet on what country can reinvent itself, I would bet on the U.S. over Europe and Japan.”
The weakening prospects of the euro to serve as an alternative reserve currency also are being accompanied by a weakening outlook in China — partly resulting from recession in Europe — that also is pushing back speculation of the renminbi moving toward internationalization.