ECONOMY

Euro escaping crisis stigma greets third Merkel term

The start of Angela Merkel’s third term as German chancellor is coinciding with a derivatives market showing the most confidence in the euro area since before the worst financial crisis since the Great Depression.

The premium traders pay to exchange euro-denominated loans for dollar funding for one-year has fallen to the lowest since March 2008, before the collapse of Lehman Brothers Holdings Inc. triggered a global credit rout and Greece sparked Europe’s sovereign-debt crisis. The euro is up 5.3 percent against a basket of nine major peers in 2013, the biggest jump in the group and poised for its first annual gain in five years, Bloomberg Correlation-Weighted Currency Indexes Show.

“A lot of things that people thought were going to happen haven’t happened,” Greg Gibbs, a senior currency strategist at Royal Bank of Scotland Group Plc in Singapore, said Sept. 20 in a phone interview. “Governments of Portugal, Spain and Italy are still operating even though they have high levels of unemployment.”

Greece just posted its biggest current-account surplus since at least 2000, and Merkel’s re-election boosted confidence that nations from Spain to Italy would stick to austerity measures that kept them from defaulting. Growth is gathering pace 14 months after European Central Bank President Mario Draghi pledged to do “whatever it takes” to save the euro.

Renewed Faith

International investors are expressing renewed faith in Europe, according to the latest Bloomberg Global Poll, published Sept. 12. Forty percent of the responding investors, analysts and traders who are Bloomberg subscribers said the euro-area economy is improving, more than four times the number in May.

Strategists have been capitulating on bearish euro calls as the currency rose to a seven-month high of $1.3569 on Sept. 19. The median of more than 60 estimates in a Bloomberg survey is for it to end the year at $1.29, compared with $1.3472 at 8 a.m. in London. In July, the median forecast was $1.26.

The one-year cross-currency basis swap between euros and dollars shrank to minus 6.8 basis points, from minus 24 at the end of last year and minus 106.5 in late 2011, data compiled by Bloomberg show. In the five years before 2008, the measure averaged 1.39 basis points, or 0.0139 percentage point.

Commerzbank’s ‘Changer’

A negative swap rate signals that investors are willing to receive reduced euro interest payments to obtain dollar funding, and a smaller spread signals more confidence in the European currency. The spread widened to minus 132.5 in October 2008, after Lehman’s bankruptcy. It then shrank before expanding again on speculation some European banks were on the brink of failure.

Commerzbank AG, Germany’s second-biggest lender, boosted its year-end forecast for the euro to $1.35 from $1.27 before the Federal Reserve said last week it would continue to print enough dollars to buy $85 billion of bonds every month.

“The Fed was a game changer for us,” with the resulting drop in borrowing costs around the world making rate cuts from the European Central bank less probable, Ulrich Leuchtmann, the head of currency strategy at Commerzbank, said in a Sept. 23 phone interview. While euro-region “rate cuts are certainly not completely written off,” ECB policy makers will “discuss them with less urgency now than they did,” he said.

Defaults Sidestepped

Commerzbank sees the euro at $1.31 in June, compared with an earlier prediction of $1.23, Leuchtmann said. RBS is the most bearish of the strategists surveyed, calling for a drop to $1.24 by year-end.

Confidence that the euro region’s most-indebted member states have sidestepped default has pushed down borrowing costs.

The extra yield investors demand to hold Spain’s 10-year bonds instead of benchmark German debt fell to 2.32 percentage points on Sept. 23, the least since 2011 and down from 6.5 percentage points in July 2012. Italy’s yield premium narrowed to a two-year low of 2.27 percentage points on Aug. 19, from 5.75 points in November 2011, data compiled by Bloomberg show.

In Portugal, the third euro member to get a bailout after Greece and Ireland, the spread was 5.18 percentage points today, after touching 3.77 percentage points in May, the lowest since February 2011. Portuguese Prime Minister Pedro Passos Coelho managed to keep the nation’s government intact amid a rift over budget policy in July.

Recovery Signs

Draghi’s pledge to stand behind the euro region led to the ECB’s still-unused Outright Monetary Transactions bond-buying program. That and unlimited bank loans under its Longer-Term Refinancing Operations helped push borrowing costs lower.

The ECB left its main refinancing rate at a record-low 0.5 percent on Sept. 5 for a fourth month, in a decision predicted by all 47 economists in a Bloomberg News survey.

Even with the euro region grappling with a record 12.1 percent unemployment rate, investors are taking comfort from the currency bloc emerging from its longest-ever recession earlier this year. The euro region economy expanded 0.3 percent in the second quarter, in line with a previous estimate, the European Union’s statistics office said Sept. 4.

Greece reported a current-account surplus on Sept. 18 of 2.73 billion euros ($3.7 billion) for July, the most since it joined the euro in 2001 and up from 663 million euros the prior month, according to central-bank data.

Prime Minister Antonis Samaras forecast Sept. 7 that the nation’s recession “will be shallower than forecast” this year. Greece’s gross domestic product shrank an annual 3.8 percent in the second quarter, compared with a 4.6 percent contraction in the prior period, official data showed Sept. 6.

Euro Austerity

Merkel, who led Germany’s efforts to get Europe’s most- indebted countries to accept economic reforms in return for financial aid, secured the highest share of votes in Germany’s Sept. 22 elections since Helmut Kohl in 1990.

She said a day later she won’t change course on European policy. Merkel’s Christian Democratic party fell short of a majority in the lower house of parliament, leaving it needing a coalition partner to govern the continent’s biggest economy.

Options traders are reducing bets on declines in the euro, according to data compiled by Bloomberg.

The premium for six-month options granting the right to sell the shared currency against the dollar relative to those allowing for purchases fell to minus 1.52 percentage points on Sept. 19, so-called 25-delta risk reversals show.

“There’s a lot of comfort right now with what’s going on in Europe,” Douglas Borthwick, the head of foreign exchange at Chapdelaine & Co. in New York, said in a Sept. 23 phone interview.

[Bloomberg]