Published November 25, 2011
Bank of America Merrill Lynch (BAC) became the latest investment bank to open the door to the once unthinkable collapse of the euro, underscoring the deepening investor fear about Europe’s debt debacle.
The brokerage said it now sees just three outcomes for the euro zone: fiscal integration, a limited liability partnership and a breakup, which is not its baseline scenario.
“Any break-up or withdrawal from the [euro zone] would unlikely be orderly. There would be large shocks to all currencies involved,” BofA Merrill Lynch foreign exchange strategists Richard Cochinos and David Gray wrote in the note.
If the euro broke apart, it would likely entail a full dissolution with all countries returning to their original currency or a partial union with only some nations exiting -- the more likely outcome, BofA said.
Under the partial breakup outcome, the analysts projected an “initial shock” that would cause a “violent swing in the euro,” followed by the currency settling about 2% lower on Germany’s departure and 2% to 3% higher in the case of Spain, France and Italy leaving.
In the less likely scenario of a total breakup, BofA said the currencies of Germany, Ireland and the Netherlands are undervalued against the U.S. dollar, while that of Spain, France, Italy and Portugal are overvalued.
Hurt by continued concern over European policymakers’ inability to achieve a long-term fix to the debt crisis, the euro was recently off 0.47% to $1.3281.
It is important to note that like most analysts, BofA still isn’t betting that the euro will in fact break apart. There are many painful costs associated with a collapse of the currency union that will likely keep politicians hammering away at efforts to preserve the euro zone.
“We should stress that a breakup of the [euro zone] is not our base case. However, it is worth examining the currency implications of a possible break-up in the current environment,” the analysts wrote.