The puzzle plaguing market participants is how the euro can be so resilient given the trouble in Greece
Nomura's Jens Nordvig looks at the possible explanations.
1) Noise is at play. One interpretation is that the Greek news is feeding into the Eurostoxx and peripheral spreads in a fashion consistent with past correlations, and that EUR will soon follow. In other words, the price action in recent days in FX space is noise, which should be ignored, as old correlations will re-establish themselves soon.
2) Greece itself ultimately does not matter too much to EUR. In a world where contagion effects can be controlled though the enhanced backstop infrastructure (ESM, OMT, QE). In this world, ending the Greek drama may remove some uncertainty, and perhaps support the euro on the margin (if there are second-round effects; in terms of political contagion to other countries, that is a different matter, but we have not seen much of that).
3) EUR is the new JPY. This means that risk aversion is increasingly supportive of the euro. This makes conceptual sense, since the Eurozone has the world's lowest interest rates (excluding the smaller European economies). As such, even home-grown risk aversion can counterintuitively support the euro (like the Japanese earthquake did for JPY back in 2011). There has been some evidence of such patterns over the last six to nine months, but it has not been completely clear cut in correlation.
He humbly admits to being on the wrong side of trade and puzzled by the resilience (he's not the only one).
The bottom line is that the relationship between Greek news and the Euro is far from simple. We have been observing up until recently that the Euro had a tendency to trade down on bad Greek news, albeit with increasingly moderate effects.
As such, we would have expected a final move down in the euro on the back of the headlines we have seen in recent days. A move from 1.12 to 1.10 would have been consistent with that template, for example. But here we are. Much of the bad Greek news is out of the bag, although some are still holding out hope for a last-minute miracle, and the Euro has traded from 1.12 up to close to 1.13.
We are somewhat surprised by the price action in recent days. We recommended fresh EUR/USD shorts last week (see Re-entering the EURUSD downtrade, 11 June 2015), as past correlations suggested that news flow would have supported the position. But how to interpret its failure to do so is unclear and we are going to wait until after the next FOMC to make any fresh trading decisions.
We are in a transition phase. Correlation to Greek news used to be high (2010-12), then turned much more moderate, and eventually it will fade (when Greece is no longer a member of the Eurozone it will hardly matter as much for the euro). But it is unclear if the price action in the last few days signals that the transition is now complete or whether we still have a final gasp of correlation left (on the actual headline of capital controls being imposed, for example).
This is a tactical consideration and we will decide in the next few days whether or not to build on our EUR/USD short positions. But the domino theory, which is of strategic importance, looks likely to be wrong in any case.
