Year Three of Debts and Bailouts for the Euro

The euro is still alive! Well, at least for another year. Despite speculations of naysayers, nobody from the euro zone clique got kicked out or left. That doesn’t necessarily mean that the euro had a good year in 2012 though!

Looking back to the year that was, we actually see that the shared currency danced to the same tunes that it did in the past two years: debts and bailouts.

EUR/USD Chart

Not the best, but off to a good start

The euro didn’t rally from the get-go of 2012. Talks of a Greek default gained steam as the debt-ridden country was threatened by other countries that if it didn’t step up its efforts to straighten its balance sheets, it wouldn’t be given its next tranche of aid.

But soon enough, the euro was able to find its footing as the ECB sounded relatively optimistic at its first rate statement for the year. Amid speculations of a rate cut, the ECB held its ground and ECB President Mario Draghi even mentioned that the region’s economy was showing signs of stabilization.

At this point, it was clear that Greece was desperate for some moolah. Everyone knew that at the risk of a Greek default, debt contagion was a real possibility. This made markets optimistic that investors would agree to the country’s debt deal and accept haircuts.

The euro’s situation goes from good to bad to worse!

After the euphoria died down in Q1, market participants realized that a recession could be in the cards for the euro zone. PMI reports from the region’s biggest economies, Germany and France, printed worse-than-expected, one after another.

With this, investors also soon became impatient with the ECB amid the backdrop of an intensifying debt crisis. The central bank initially said that it would wait for the effects of its LTRO program to take effect first before taking on any action. However, Spain’s and Italy’s bond yields were already rising to unsustainable levels.

Politics also made the situation all the messier for the euro. The term “Grexit” became popular as the anti-austerity camp in Greece gained more popularity. Meanwhile, EZ policymakers failed to see eye-to-eye on how to address the region’s debt crisis.

Plagued with all the above-mentioned problems, the ECB finally became more open to the possibility of further easing. Of course, that only gave investors one more reason to sell the euro. And come July, the central bank finally cut rates.

At rock-bottom, there’s nowhere else to go but up

Just when it seemed like EUR/USD was poised to make a run for the 1.2000 handle, Draghi steps up to the plate. He makes a pledge that policymakers would do whatever is necessary to preserve the currency. Market participants didn’t really know what to expect but the ECB’s absence at the Jackson Hole Symposium only intensified the anticipation.

Come September, the ECB finally announced its bond-buying program around the same time when the Fed announced QE3. The euro reacted positively to Draghi’s remarks about the ECB being ready to buy bonds in unlimited amounts. Soon enough, borrowing costs began to ease from their highs.

Of course, it also helped that the region’s political landscape started to improve too. Germany, who had initially been against the idea of using the ESM to buy bonds of debt-ridden countries, finally ratified the motion. Spain also passed its budget plans which was interpreted by many as the first step to asking for a bailout.

Back to the beginning

However, the skeletons in the euro’s closet continue to haunt it. Economic reports came in worse-than-expected and downgrades came one after another towards the latter part of the year. Heck, even France got slapped by one from Fitch!

Spain’s stubbornness to ask for a bailout and the need for more liquidity for Greece also took their toll on the currency too. But soon enough, when policymakers got their act together and Spanish banks tapped the EU’s credit line and the approval of another Greek debt deal on the backdrop of U.S. fiscal cliff woes quickly boosted the euro. Now the pair is trading near where it started in the beginning of 2012!

2013 will definitely be another exciting year for the euro. However, in this old man’s opinion, I think we’ll see much of the same from the shared currency. Talks of piling debt and the threat of a widespread contagion will still be there. Perhaps it might even be better if we start bracing for the worst. Who knows, maybe a euro zone break up will happen within the year!

Of course, I do hope for the best. By avoiding a breakup this year, and with recent fiscal and monetary policy changes, the situation in Europe may continue to stabilize. Whatever the case may be, I’ll be here to analyze the events and hopefully keep ya on the right side of the trade!

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