Backing Off The Forward As Portugal Nears The Edge

Some of you will remember me mentioning the boast of a contact of mine, about the mouth-watering gains they were seeing in an obscure little EUR/USD position entered on 21st November last year.

You might recall that 21st November was the Sunday night before things started kicking-off in a big way in Ireland. Ireland de facto accepted assistance from the European Financial Stability Facility mechanism, not long afterwards.

Without wanting to go into too much detail my contact’s position is this: they sold short 1,000,000 lots of a ‘rolling’ overnight, non-deliverable EUR/USD forward.

[So you can immediately surmise that the account is an institution, at least!]

I set up a feed for the contract using Blue Systems and watched the P/L percentage rapidly surpass 100% and stay well above that level ever since, with forays well over 230% at times.

Each contract was worth 30 euro cents. And as the dark clouds have returned over the euro zone with the revival of activity and volumes following the holiday break, the win in percentage terms today has been hovering around 150%; and twice today it’s touched 220%.

I said my contact’s position ‘is’, but in fact it ‘was’: it was at one of those elevated points, today, that the contact said they liquidated the position.

I don’t know anything about the dealing or funding costs [although it’s useful to note the thing was open for an awfully long time.]

However if you judge P/L purely on a ‘gross/gross’ basis, the profit & loss column today with the percentage gain showing 220%, equated to EUR660,000.

Why is this important? [Apart from the fact that the relative ease with which a large institution can capitalize on the travails of a nation – and I’m sure you can imagine there are even easier ways that powerful institutions can do so – throws up a bunch of potential moral issues…]

I think you know already. But my humble take follows.

As the euro zone continues to go through it’s crisis, it’s looking likely, as many had suspected, that Portugal’s euro-denominated sovereign debt is the next nation’s paper to come under attack from speculators, hedge funds and even those with more ‘noble’ needs [shall we say] to protect capital assets [managers of large pensions funds, for instance.]

However, headlines in the last 48 hours have shown the sequence of events is following the ‘playbook’ which was set out in the crises of Greece and Ireland, so far.

Crudely speaking, euro sovereigns being targeted deny, deny and deny. Then they inevitably capitulate.

Over the weekend, the denials started.

But whatever Portuguese government officials might want to be true, we will discover what actually is true about the value of its paper on Wednesday.

The government will auction EUR750 million-to-EUR1.25 billion in total of 3.60% bonds expiring October 2014, and 4.80% paper expiring June 2020.

The auction commences at 1030 GMT.

Once again, a playbook has been established for these inter-crisis-peak auctions. There’s usually been little problem getting these offers away recently. Little difficulty, that is, so long as the state concerned is prepared to accept interest rates creeping up each time it sells a comparable set of paper.

So the account described above decided that for the near-term at least, it was probably not worth attempting to aggressively push EUR/USD lower still from current multi-month lows, and by implication now was not a bad time to take some profit on the trade.

If you were a Portuguese finance ministry official, I’d wager that that might not be much of a comfort for you right now.


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