Hedge funds bet against euro, shirk CDS, in crisis

By Laurence Fletcher

LONDON (BestGrowthStock) – Hedge funds are betting the euro will fall further as Europe’s sovereign debt woes spread but have largely abandoned bond insurance trades given uncertainty over political interventions following Ireland’s bailout.

Some are shorting the euro or taking long positions in the Australian dollar or Norwegian krone versus the euro, betting interest rates in those countries will rise while euro zone rates will stay low.

“The bulk of the action has been through the currency,” one fund of hedge funds manager who declined to be named told Reuters, adding that “relatively few” funds had bet on credit default swaps (CDS) — insurance against bond default.

“The reason is that (currency) is the most liquid market. If you think there is another leg to peripheral Europe’s problems, the euro is definitely a way to express it.”

The euro rallied briefly after Europe agreed an 85 billion euro ($110.7 billion) emergency aid package for Ireland on Sunday, but has since continued its fall as fears have grown that the debt crisis will deepen.

The single currency has dropped from more than $1.40 earlier this month to hit an 11-week low below $1.30 on Tuesday.

Pedro de Noronha, managing partner at Noster Capital, has no exposure to CDS but is short the euro and said that despite recent falls the euro “still has legs to go down.”

“Given the issues that this group of countries is facing it is very hard to understand how the euro is so strong given the obvious ineptitude of the euro to serve as a ‘one size fits all’ currency,” he said. “Euro strength is not due to fundamentals but simply related to central bank reserve diversification. The euro should be closer to parity than to $1.50 in our view.”

POLITICAL RISK

Many hedge funds see credit default swaps on indebted European countries — which have blown out to record levels — as no longer attractively valued and fear the uncertainty caused by political intervention, as politicians and central bankers argue over rescue packages.

Markets are already pricing in a Portuguese bailout — and maybe for Spain too — following those for Greece and Ireland.

“There’s not so much (in bonds) as one might think. People recognize there’s a lot of political risk,” said Morten Spenner, chief executive of funds of hedge funds firm International Asset Management. “They prefer to play the currency.

“In Greece, they invested before (this stage). Once it gets political they pulled out. Now everyone’s talking about it, the value has been (and gone). They’re not trying to predict what the ECB is going to do.”

The cost of insuring 10 million euros’ worth of Irish bonds against sovereign default rose to 625,000 euros on Tuesday as markets showed their skepticism over Ireland’s bailout package.

Five-year CDS on Spain and Portugal both widened by 22 basis points to 373 and 560 points respectively.

While a number of hedge fund firms said they had steered clear of Ireland, one executive said his firm was looking at trades such as the spread between a well-rated Spanish corporate and Spanish government bonds.

Some Spanish companies are now trading below the country’s sovereign bonds, but the executive said he was still undecided whether the gap would widen further, or whether it would tighten — and whether he would go long or short accordingly.

(Editing by Mike Peacock)

Hedge funds bet against euro, shirk CDS, in crisis