The Untold Euro Story

Aren’t you sick of this European crisis?

It’s always the same story. After the region goes into some sort of crisis, European authorities promise a “comprehensive plan” to save the day. Then markets realize nothing really has changed, and the crisis makes a comeback.

I’m sure you’re also tired of hearing about the PIGS. So I promise I won’t talk about them.

I’m here to tell you about a side of the European debt crisis that few people are talking about.

There’s a group of countries outside the eurozone that will suffer the most from the ongoing debt crisis. And that’s where you will find the best trading opportunities. Let me explain…

Three Countries that are Catching a Cold

While everyone is focusing on Greece, Portugal, Italy, and Spain, there’s a group of other European countries that are also in danger. I’m talking about the Czech Republic, Hungary and Poland.

There are two mechanisms that will ensure a major contagion in the region: exports and banks. Let’s take a look at exports first.

Those Eastern European countries – all of which are part of the European Union’s 27 member states  – have very tight trading relations with the Eurozone. So when the Eurozone sneezes, they definitely catch a cold.

The Czech Republic provides a good example. In the past 12 months, the country exported an amount equivalent to 49% of its economy into the euro region.

That makes the Czech Republic the most exposed emerging market to the Eurozone.

But it’s not the only one. Hungarian exports into the Eurozone made up 44% of that country’s GDP, while Poland exported 20% of its GDP to the region.

With the euro economies heading to a recession, the demand for eastern European exports will decline. That will have a big impact on those smaller economies.

Credit Crunch Will Make Things Worse

Besides exports, the crisis is also spreading through bank activities. European banks are under a lot of pressure to shrink their loan books.

Over the next few years, they will have to bring themselves into line with global Basel III rules on capital adequacy. What’s worse, they must comply with tougher targets set by the European Banking Authority, the pan-EU regulator, by June of next year.

That’s forcing banks to reduce their loans to improve their capital ratio. In other words, banks won’t be lending as much as before. And that’s leading to a credit crunch in Europe, especially in emerging market countries.

Western European banks control nearly three-quarters of Eastern Europe’s banking system. So Eastern Europe is the most vulnerable region.

And the banks with the biggest presence in the region are among those with the biggest troubles back home. The Italian bank UniCredit, which is having a tough time trying to keep its head above the water, is the number one lender in the region.

The bank already said it will reduce its exposure to Eastern Europe in an attempt to reduce its loans. Germany’s Commerzbank also said it will restrict new lending only to Germany and Poland. Many other banks in the region have embarked on aggressive shrinkage.

This credit crunch almost guarantees a recession in those countries.

The Best European Currency to Short

Shorting the Eastern European currencies against the dollar is a great way to profit from the ongoing European crisis.

Unfortunately, most traders only focus on the euro, and they end up missing better opportunities in those smaller, less known currencies.

For me, shorting the Czech koruna against the U.S. dollar is the best way to profit off the euro crisis right now. As you can see in the chart below, the other eastern European currencies have already fallen a lot over the past six months. So the koruna has more downside risk.

Czech Koruna Will Catch Up With Others

Subscribers to Exotic FX Alert have already been capitalizing on that trend by capturing most of the Hungarian forint’s move downward.

Those who followed my recommendation to short the forint a few months ago grabbed 300% in a couple weeks.

And that’s pretty much the only thing I like about the European debt crisis: it gives us plenty of trading opportunities.

Right now, shorting the koruna is looking like another promising trade.

Best regards,

Evaldo Albuquerque
Editor, Currency Capitalist