3 Reasons Why the Euro Collapsed

That the euro zone economy is in deep trouble has never been a secret to market participants. So what exactly caused the euro’s dramatic plunge against its counterparts last Friday? Here are three possible reasons:

1. The ECB took on a dovish stance

Unlike the SNB, investors have little incentive to want to own euros, except perhaps to use it for carry trades. After all, the ECB had raised its interest rates by a quarter point in April and again in July on grounds of increased inflationary risks. But when the ECB kept its September rates steady at 1.50% AND lowered its inflation forecasts last Thursday, the central bank might have tipped the investors’ scales in favor of dumping the euro.

In his speech, ECB President Jean Claude Trichet said that inflationary risks are now “broadly balanced,” which is a departure from the “upside risk” rhetoric that the bank had been giving in the previous months. What’s more, Trichet also revealed that the downside risks to the economy have intensified, which not only confirmed investors’ fears, but which market geeks also translated to mean “no interest rate hikes at least until next year.”

2. ECB member Jϋrgen Stark unexpectedly resigned from his post

As if the ECB‘s dovishness hasn’t done enough damage to the euro, Jϋrgen Stark, an influential ECB Executive Board member, rocked the boat some more when he unexpectedly resigned from his post last Friday. Stark, known for being hawkish and is considered by many as the gang’s chief economist, had three more years left on his term.

Though Stark cited personal reasons for leaving his post, many analysts believe that his reasons have nothing to do with wanting a long vacation in the Bahamas or making his own Iron Man suit. Word on the street is that Stark has had enough of the ECB’s buying of government bonds from financially troubled economies (a.k.a. PIIGS).

If this is the case, then Stark’s resignation signals a deeper divide among the ECB members than markets had originally thought. This would put even more doubts on the ECB’s capability to prevent a full scale debt contagion in the region, and might make investors more wary of holding on to their euros.

3. Germany preparing for Greece default?

The cherry on top of the euro bears’ sundae was the rumor that German Chancellor Angela Merkel and her peeps are preparing for a scenario wherein Greece would fail to meet its bailout package requirements and finally default on its debts.

According to three coalition officials, Merkel is setting up plans to protect German banks, which could lose as much as 50% of the value of their Greek bond holdings in the event of a Greek default. Ironically though, the rumor started spreading almost right after the Greek Finance Ministry denied the possibility of a Greek default over the weekend. So much for confidence!

In any case, the combined onslaught of the three major reports cited above caused EUR/USD to crash by 227 pips, while EUR/JPY also plunged to an intraday low of 105.30, 212 pips away from its open price. The question is, have we seen the worst of the market’s reaction, or are the euro bears just warming up?

Over the weekend the euro zone officials will probably try to calm investors to prevent more panic in markets. Greek Prime Minister George Papandreou has already delivered a televised address expressing his confidence in sticking to the Greek government’s austerity plan, while Germany has also nominated Deputy Finance Minister Jörg Asmussen to take over Jϋrgen Stark’s post.

We can’t tell how markets will react to these reports on Monday, but the euro bulls will most likely see more pain, at least in the first few sessions. Make sure you stick around for any new developments, alright? Or better yet, why don’t you keep in touch with me on Twitter and Facebook for any updates?

Enjoy the rest of your weekend, folks! We’re in for more crazy price action next week!

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>