Mixed signals regarding strength of euro place forex traders in a quandary; Hypo fails the E.U. bank stress test putting German taxpayers on the hook

Forex traders pulling their hair over the euro – Given the recent steady climb in the value of the euro against the U.S. dollar, the questions being asked are when and where will the appreciation elevator stop? In a report that was released on July 12 when the euro was nudging 1.2600 USD, analysts at the Royal Bank of Scotland (RBS) said the euro was approaching fair value against the dollar. This would suggest a reversal of any significant movements over a period of time, according to RBS. Developments over the past several days suggest the climb may soon be over, or not. Consider the following. Moody’s Investor Service has just downgraded Ireland’s credit rating while Fitch Ratings has just upgraded the credit posture of Estonia, a country poised to become the newest member of the euro-zone on Jan. 1. The latest data from the European Central Bank indicate that the bank’s intervention in European bond markets has been on a significant downward slope in the past weeks. On the other side of the pond, the latest data show weakness in U.S. home construction which has been attributed to the demise of the first-time homebuyer tax credit. In Washington and in financial centers worldwide, all eyes are now focusing on the July 21 appearance of Ben Bernanke, chairman of the Federal Reserve, before the Senate Banking Committee. And in Europe, the forex market has its eyes on the results of the E.U. bank stress tests which are due to be released on July 23. At press time (July 20 – 9:53 a.m. in New York), the euro was trading at 1.2866 USD.

Hypo adds another disappointment to its recent history – Reports began leaking out on July 19 that the first casualty of the E.U. bank stress test is Munich-based Hypo Real Estate Holding. This is already causing some distress among forex traders. There is good reason for such concern. Hypo reportedly has insufficient reserves and has been victimized by its exposure to the real estate market and sovereign debt holdings. It was bailed out in 2008 to the tune of 7.8 billion euros by the German government and is, in effect, nationalized. The bank may now need an additional 2.2 billion euros in recapitalization. Just as in the U.S., bank bailouts are unpopular in Germany and there are fears, perhaps unwarranted, that an infusion of more taxpayer cash for Hypo could fracture Chancellor Angela Merkel’s governing coalition. How that would play out within the euro-zone is unclear but it is a possibility that forex traders should keep in mind. According to its website, Hypo is in the process of realigning its business as a specialist bank for real estate and public finance with its focus always on the eligibility of business for Pfandbrief (mortgage-backed securities) funding.