Euro Resurgence or Dollar Weakness? The Week in Review

Has the risk of sovereign default in the Eurozone vanished? You might be forgiven for thinking so this week with the euro gaining almost 3% against the US Dollar and ranking among the best performing currencies this week. Most other currencies had similar success against the weakening US currency. The Australian Dollar moved up 3%, the Canadian Dollar 1.8% and the Swiss Franc 1.8%. The currency market may appear blasé about the EMU debt problem but European credit markets take no such sanguine view of the continent's sovereign debt prospects. Greek 2-year notes were yielding over 21% on /Friday, Irish and Portuguese bonds over 10% each. These secondary market interest rates predict debt restructuring for the afflicted countries. Greek credit default swaps signaled a 67% chance of default within five years.

Over the past two months the euro has been at best a fair performer compared with the dollar's other major competitors. Since the beginning of March the euro has appreciated 5.8% against the US currency. But in that same period the Australian Dollar has added 10.6%, the Swiss Franc 5.5%, and the Canadian Dollar 4.3%. Only the yen has managed to remain largely unmoved, depreciating 2.0%, with a Japanese economy buffeted by earthquake and tsunami damage and G-7 currency intervention.

The six month view is more pronounced, the euro has been the weakest major currency opposing the dollar. Since last November the euro has climbed a mere 1.9% versus the dollar while the Australian currency has gained 12.5%, the Swiss Franc 11.9% and the Canadian Dollar 7.3%. The weakness of the American Dollar which is evident in all of its trading pairs is mitigated to a substantial amount versus the euro. The difference is the EMU debt crisis. Even the assumption of a rate hike cycle by the European Central bank has not provided the united currency with any substantial lift.

The Euro-Dollar trading pair is the most heavily traded in the currency markets. But with both of the currencies that make up the pair, the euro and the US Dollar under strain traders have moved their positioning to the smaller major currency pairs and outside of the currency market altogether. Gold is 15% higher since January; West Texas Intermediate crude is up 33% since mid-February and Brent crude is 25% higher, and not that entire price differential is due to speculation on future demand or the translation from a weaker dollar.

The EMU debt crisis may have moved out of the immediate headlines, but the inability of the European political system to write an end to the problem is taking a serious toll on the euro. Indeed it may well be driving some traders out of the currency markets altogether.