By Leah McGrath Goodman
Rumors of the death of the euro may be greatly exaggerated, but several players are positioned for its run at ruin. Taking that bet has been complicated, however, as the 16-nation euro zone lurches into damage control mode.
Germany is slapping bans on certain types of naked short trades and lambasting what it sees as the speculative abuse of credit default swaps on government debt, which it cannot ban. Greece, the progenitor of the sovereign debt crisis that is wracking the continent, has barred hedge funds from participating in its bond sales. In response, many traders are simply shrugging and turning to less controversial ways of betting on the euro’s near-death experience by simply shorting the euro.
That’s not because the bans have been effective. To the contrary, most portfolio managers point out that the restrictions have done little more than exacerbate the selling panic that’s pushed the euro repeatedly to four-year lows, while barely curbing anybody’s trading activities (the German bans, for example, apply only to traders in Germany). It’s more that traders are spotting better returns elsewhere and want to avoid getting caught up in the political backlash that suggests speculators are to blame for Europe’s woes. (For a gauge of this, look no further than reports of Greece’s intelligence service instigating probes into the trades of such heavyweights as Moore Capital Management, Brevan Howard Asset Management and Paulson & Co.)
The result has been a growing interest among traders in shorting the euro against the stronger currencies, such as the dollar, augmented by a mad dash among fund managers both inside and outside the euro zone to unwind long euro positions and hedge out euro risk, particularly in cases where they own European equities or hold the single currency in reserve.
“Are there any clear bets out there? Without stating the obvious, SHORT THE EURO!” one London trader writes in an e-mail. “The fundamentals are dire, and they seem to be getting worse. Germany can’t stop us FX traders from selling the euro, so if you have a negative outlook on the euro zone, like me, that is the way forward.”
Specifically, many traders are betting outright against the euro, which has fallen from $1.45 in early January to below $1.20 in June, in addition to pairing it with long bets on the U.S. dollar. “You can make a couple hundred of pips on the day and if you got in at the beginning of the year, you would have made over 17% by now,” says the London trader, who boasts a trailing 12-month return of more than 30%. Regulators can’t ban shorting the euro because it is traded over the counter. And the strategy makes sense, traders say, because the path of least resistance for the euro versus the dollar is still straight down and, according to some, possibly bound for parity. A popular statistic being brandished is the U.S. real gross domestic product estimate for 2010, which is seen increasing more than 3%, while the euro area’s GDP is seen rising just above 1%. The disparity is, in a word, stark.
Some portfolio managers are wary of an overreaction to the downside. “Because shorting the euro has been going on for some time, and it’s fallen so far and everyone is aware of it, that makes it a high-risk proposition,” says Kay Torshen, president of Torshen Capital Management, a fund of funds in Chicago. “The euro is investors’ global indicator of the creditworthiness of Europe. Nothing the euro zone leaders have done so far to help it has been working. But governments can be very creative when they want to be. If they take dramatic action, you’re going to get a sharp reversal. That’s why we believe any euro shorts need to be hedged.”
Gone are the days when banks, pension funds and hedge funds loaded up on the higher-yielding sovereign debt bonds of more troubled European countries—the so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain). In an unprecedented move, the European Central Bank is taking these investors’ place, buying the debt and sparking talk that what was once seen as the euro zone’s last bastion of fiscal discipline might soon become its next “bad bank.”
As a result, some of the PIIGS shorts taken earlier by many hedge funds look dicier. And some funds, such as Moore, have admitted to hewing to their net long exposure on shaky sovereign debt bonds in anticipation of, as Moore’s Louis Bacon put it, European authorities moving “beyond uninformed blame-casting [to] begin bailing out Greece.” Indeed, euro zone finance ministers in June were finalizing a €750 billion rescue package that involved not only the International Monetary Fund, but also the European Commission. As part of that, Greece was set to receive €110 billion to service its ballooning debt, which traders expect should tide it over for about three years.
The problem is, as other euro zone nations struggle with their own overblown budget deficits, the bailouts only delay the inevitable, argue the euro trashers. “My opinion on Greece is that it’s a slow-motion train wreck. There is no way they can make the cuts they propose to make and still grow their economy out of the problem. What they’re doing at the moment is just kicking the can down the road. What we’re hearing more and more of is talk of an orderly default,” says Andrew Weir, senior analyst at Stenham Advisors, a $2.7 billion London fund of funds.
If hedge funds can’t imagine a scenario in which Greece doesn’t eventually default, they also say there is no blueprint for one. “It hasn’t been formulated yet,” says David Lea, an analyst in the London headquarters of Control Risks, a political and economic consultancy. “The EU always does things very slowly. It’s kind of like a sprint cycle race, where in the beginning everyone pedals as slowly as possible because nobody wants to make the first move, and then at the end they frantically sprint for it.” In the meantime, Hugh Hendry of London’s Eclectica Asset Management bet the EU would be forced to pay for Greece and made a modest amount of money selling insurance on naked credit-default swaps on Greek debt. “This is not showing generosity to Greece,” he says. “It is showing generosity to the banks of Germany and France who bought the bad debt and were subject to great folly. Here we have Germany trying to be the second-biggest economy in the world, and they’ve destroyed that. All the fundamentalism of the ECB, the world’s last pillar of respectable hard cash, has been swept away by the politicians. And the euro’s reflecting it. In socialist Europe, the socialists keep bailing out the capitalists. I am a capitalist.”
