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(Kitco News) - Reports of the euro’s demise may be exaggerated, although that doesn’t mean traders won’t continue to fret over whether the currency is on its deathbed.

Currency strategists told Kitco News that they look for European authorities to eventually come up with programs that preserve monetary union, although the euro is likely to remain under pressure in the meantime.

The euro fell to a nearly two-year low of $1.2289 Friday, down 8% from its March high of $1.3386. The slide occurred when Greek parties were not able to form a coalition government after national elections last month, generating worries about whether the country would abide by the terms of its bailout program, and new elections were set for June 17. There are also market concerns that Spain and Italy will need bailouts as their bond yields rise, and that Spanish banks will need recapitalization.

Short-Term Short-Covering Bounce Seen, Followed By More Weakness

Despite all of the pessimism about Europe, strategists say a bounce in the euro may occur just because the single currency is oversold. “On a short-term basis, we’re definitely in extreme territory with the euro putting in new lows almost every day for about two weeks,” said Andrew Busch, global currency and public policy strategist with BMO Capital Markets.

Marc Chandler, head of currency strategy with Brown Brothers Harriman, pointed out that large speculators hold a record net-short position in euro futures.

“Because the election polls suggest a dead heat (in Greece), the market is not going to want to go into it with record short euro positions,” he said. “So I think we do get some reduction of short-euro positions before the Greek election.”

A subsequent win by the pro-bailout parties also could lead to short covering in the single currency, some strategists said.

Still, since it will take some time for Europe to deal with its issues, strategists look for weakness to resume, with Chandler suggesting the euro could fall to the $1.18-$1.17 area.

If the anti-bailout forces were to wrest control of the Greek government after the election, the euro’s initial move likely would be lower, analysts said. However, some said, the single currency may fall more anyway before finding a bottom, particularly as fears increase about the health of Spain’s banks.

“The (euro) decline in May was substantial, so there is certainly the potential for the occasional upward correction,” said Robert Lynch, strategist with HSBC. “But I would expect, barring some unexpected improvement in the backdrop, the bias is going to be to sell into corrective gains that may develop.”

Strategists Look For European Monetary Union To Survive

Still, several observers said they look for Europe to eventually find workable answers. A summit is scheduled for the end of the month.

Chandler said he looks for “more integration and not disintegration.” However, he said, this also could take some time, pointing out that some of the poorest parts of the U.S. are southern states that once left the union in the Civil War era and that eastern Germany remains economically behind western Germany despite more than two decades of reconstruction since the fall of the Berlin Wall.

Since the Greek crisis first emerged, analysts pointed out, European leaders have already increased cooperation, such as the European Financial Stability Facility and sovereign-bond purchases by the European Central Bank.

“Out of the current crisis, I think there will be new institutional reform and capacity, such as movement towards banking union, and more steps toward fiscal union,” Chandler said. “I think what Europe is doing is building the scaffolding.”

The strategists interviewed by Kitco News all look for the euro to survive and not go away.

“Our house view is that Europe does stay together and the Greece does not leave the eurozone, and they (European officials) find some method of both keeping Greece in and continuing to build on things like the firewall to ensure that stressed finances in one country don’t so readily lead to concerns or contagion risks for other countries,” Lynch said.

Many of the euro’s problems are the result of monetary union without fiscal union, Busch said. “But you can get around that if you have certain structures that are similar to a fiscal union but maybe not completely fiscal union,” he said. An example would be a bank program such as the U.S. Federal Deposit Insurance Corp., he added.

There will be increased uncertainty about the euro should Greece leave, Busch said. However, he looks for Spain and Italy to stay even if Greece doesn’t.

“You have to realize that German, French and Italian banks have 750 billion euros worth of exposure to Spanish banks,” he said. “None of those countries are going to leave Spain high and dry…I don’t think people understand the interconnections that are involved here.”

Chandler also looks for the euro to survive, pointing out that monetary union has only been around for 13 years and that there was also was uncertainty about the U.S. during the early years after it became a nation.

For one thing, Chandler pointed out, even if the eurozone is not yet an optimal currency, it has helped bring about something that previous generations could not—peace on the continent. “Integration that began in the 1950s culminated in the euro, and that integration is what makes peace on the continent possible,” he said.

Further, Chandler said, there is no “Plan B” if monetary union fails. He looks for Europe to follow the advice Benjamin Franklin once gave the 13 U.S. colonies. “You hang together, or you hang separately,” Chandler said. “I think that applies to Europe.”

 

Meanwhile, Lynch suggested the euro could rebound against the dollar “by default” later in the year as worries shift from European debt to U.S. debt.

“Longer term, we’re still concerned about the dollar,” Lynch said. “The fiscal backdrop in the U.S. is not being addressed in a serious manner at this stage…Our expectation is that the concern about sovereign risk and long-term sustainability of a government’s finances is going to rotate back and be on the U.S. in the not-too-distant future, probably toward the end of this year.”

By Allen Sykora of Kitco News; asykora@kitco.com

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