Eurozone Safety Net Still Flimsy

09/17/2012 3:05 pm EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

There’s growing opportunity in the Eurozone, but until it repairs its safety net, the risks are high, says Kathy Lien.

My guest today is Kathy Lien, and we are talking about Europe and the euro—it seems to be popping up in the news again about problems there still with debt.  So Kathy, where are we with Europe and the euro itself? 

Well Tim, in terms of Europe, we do have a little bit of a reduction in the overall risk environment.  European bond yields have fallen quite a bit—more specifically, Spanish and Italian bond yields—and that is really good news for Europe, because it means that the main cause of tension, which is borrowing costs that are very difficult to service, is no longer as serious of an issue.

But, does that mean that Europe’s crisis is behind us?  Absolutely not.  We still have people questioning whether or not Greece is going to leave the euro.  They are probably going to need an extension to their austerity program. They are probably not going to be able to meet the terms outlined in the amount of time that they have previously pledged. 

At the same time, with Spain and Italy, one bad bond auction and any whiff of bad news could easily send bond yields skyrocketing once again.  What Europe needs they have not gotten yet, and what they need is a safety net provided by the stronger countries within the region.  So far, even though we have heard talk about this possibility, which is part of the reason why bond yields and the euro have rebounded, we haven’t seen any action. 

Alright, so one of the things that has been in the news recently is that Germany has a big decision—whether they are going to kind of save the economy or have Greece fall out of the euro. Why is it all on Germany?  Why is so much weight and pressure put on Germany? 

Germany is the largest country within the Eurozone, and they are the soundest in terms of financial health. So they have deep pockets.  Economic data-wise, they haven’t fallen into the recession that some of the other countries have.

So they lead the euro, and that is why a lot of people are looking to the Germans in order to receive funding.  If you think about it, Spain and Italy can’t afford to bail out any other countries, because they are pretty much in dire straits themselves. So it really lies on Germany and France, and really more Germany than France.

German taxpayers have already been asked to pay higher taxes in order to save their neighbors, and they are reluctant to do more. It is really politically unpopular for Angela Merkel to ask them to do more, but it is unfortunately what needs to be done.  I think in the long term this will pay off, but it can be done in a couple of different ways.

You have the possibility of Germany lending their AAA rating and allowing for the introduction of euro bonds.  Yes, Germany will probably have to pay a higher yield, but hopefully it will be temporary and not permanent. Once the situation fully pacifies, hopefully the yields will come back down for everyone. 

There is also talk of the ECB capping bond yields in Europe.  It is not the fiscal solution, but it can certainly help psychologically and practically. So there are a lot of different options that they have; none of which they have acted on yet, and that is really the most important thing to remember. 

Finally, how do we trade this?  How do we trade the euro going through the end of 2012?

When it comes to trading the euro, we have a tremendous amount of short positions built up in the euro/dollar. This is very important to remember, because any type of good news—regardless of whether it is substantiated or not—turns out to be very positive for the euro and can lead to quite a large short squeeze.

But at the end of the day, I think that a lot of investors want to believe that the euro is here to stay.  So I would be cautious about selling euros until we really see the Europeans throw their hands up and say we can’t do anything else. 

On the flip side, if we do get any kind of concrete announcement in the form of greater support by Germany and by other countries, that will probably mean a tremendous trend change for the euro/dollar and a full bottom. At that point, it won’t be a one day, two day, three day move. It will probably be a move that lasts for weeks, months—I don’t want to say years, but probably a couple of months. That is really a nice thing to focus on, because for longer-term investors that is really an opportunity to get into the euro for a longer-term shift in trends. 

Kathy, thanks for your time.

My pleasure.

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