Dollar Surges on Europe Downgrades

The dollar surges to an 11-month peak overnight, boosted by sovereign credit concerns in Europe after Standard & Poor's downgraded Greece and Portugal.
By Omer I. Esiner ,

By Omer Esiner of Travelex

The dollar surged to a new 11-month peak against a basket of its major counterparts overnight, broadly boosted by mounting sovereign credit concerns in Europe.

Yesterday, Standard & Poor's ratings agency downgraded Greece's government debt to junk status amid mounting concerns about its ability to finance its soaring debt. Concerns about contagion to other eurozone nations and the soaring cost of financing government debt prompted S&P to downgrade Portugal as well yesterday.

Uncertainty over the amount and timing of a financial aid package for Athens has kept investors wary of holding Greek assets, and this was clearly illustrated in the rise in the premium investors are charging the Greek government to borrow. The resulting drop in investors' appetite for risk saw traditional safe-haven assets like the greenback, the Japanese yen and gold all soar as higher-yielding and riskier investments tumbled.

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The pound fell further from recent highs as investors began to focus more on the likelihood of a hung parliament in next week's general election. The resulting political gridlock is seen as limiting the government's ability improve its own dire fiscal situation.

Investors await this afternoon's announcement on monetary policy from the

Federal Reserve's

Federal Open Market Committee (FOMC). Although investors expect no change in interest rates, market participants are on the lookout for any subtle change in language that could signal monetary normalization may come sooner than previously expected.

EUR

: The euro tumbled across the board yesterday after S&P downgraded both Greece and Portugal. The move came as the plummeting value of peripheral eurozone government bonds (and the resulting spike in yields) continues to make borrowing by countries like Portugal, Ireland, Italy, Greece and Spain, the so-called PIIGS of Europe, nearly impossible.

At one point, the yield spread between 10-year Greek and German government bonds was more than 10% and on a two-year basis, the market was charging Greece three times what it charges Germany to borrow money.

A similar, if less drastic, blowout in spreads across Europe highlights the market's angst about the possibility of contagion from Greece to the rest of the PIIGS.

Overnight, eurozone officials downplayed the likelihood of a debt restructuring or default for Greece, saying that the requested aid would be provided very soon. The suspension of short-selling of financial stocks on Greek bourses also helped ease some of the overall negative sentiment surrounding Greek assets. Although credit spreads have narrowed and the euro appears to have regained its footing, the high level of uncertainty in the outlook for Greece, along with the potential for contagion of the crisis to other areas of Europe, will continue to leave the single currency very vulnerable.

GBP

: The pound was affected by the mounting sovereign concerns in continental Europe.

The high likelihood of a hung parliament in the May 6 election raises serious risks of political gridlock in the U.K., an outlook that will severely limit any government's ability to enact difficult fiscal reforms.

The debt concerns in Greece had distracted market players from that outlook for some time. However, the worsening eurozone credit issues have shined the spotlight back onto the U.K.'s own debt issues, which in many ways parallel those of Greece and other peripheral eurozone nations. Continued risk aversion and political uncertainty should continue to keep the pound under pressure, especially as the event risk of next week's election looms.

AUD

: The Aussie fell to a one-month low amid the broad backdrop of risk aversion throughout global financial markets. Investors' heightened nervousness overshadowed the rise in the first-quarter consumer price index in Australia overnight. Consumer prices rose by 0.9% quarter over quarter in the first quarter, slightly more than the 0.8% expected. Year over year, inflation rose to 2.9%. Although the CPI data suggest that the Reserve Bank of Australia will likely raise lending rates again by 25 basis points when it next meets in early May, mounting sovereign uncertainty could limit the scope of upcoming policy tightening by the RBA, and other central banks for that matter.

CAD

: In a speech yesterday, Bank of Canada Governor Mark Carney echoed recent commentary from the central bank, saying that the economy's resilience, which surprised policymakers, has dampened the need for such an accommodative policy stance.

Although Carney did reiterate that a strong Canadian dolalr was a key risk to the bank's robust growth outlook, he did acknowledge that the loonie's value was a reflection of the strong economy, solid fiscal standing and high commodity prices. His comments were consistent with an outlook for a BOC rate hike in early June. The loonie could suffer additional near-term losses as a result of mounting risk aversion, but its downside should remain limited by the hawkish rate outlook.

Omer Esiner serves as the Senior Currency Market Analyst at Travelex, Inc. a global financial institution specializing in corporate foreign exchange services and international payment solutions. In this capacity, he monitors, analyzes and interprets the economic, financial, political and technical factors that drive the movements of more than 100 currencies for Travelex. Mr. Esiner explains the currency markets' reaction to market events to clients, employees and members of the media.

You can view his daily reports, recording briefings, and quarterly reviews posted

here

. As an expert in foreign exchange, Mr. Esiner is quoted regularly by the financial media including The Wall Street Journal, CNN, Dow Jones Newswires, Reuters, the Nightly Business Report, National Public Radio, among others. Based in Washington, D.C., Esiner joined Travelex in February 2000. Prior to his current position, Esiner was a currency trader for several years. Mr. Esiner holds a bachelor's degree in economics from the University of Maryland, College Park. He is fluent in Turkish and proficient in Spanish.

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