Hungary Takes the Euro Hostage, But Watch Out for Short Covering

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Most people were probably unaware that lawmakers in Hungary had recently re-written its entire constitution. The new so-called Basic Law took effect Jan 1st and now has everyone up in arms. Tens of thousands protested against it in Budapest on Jan 2nd (see Reuters article) and many EU and US leaders have officially expressed concern. The controversial law appears to limit the independence of the judiciary, the media and the central bank. The concern that the central bank will have to do the government's bidding is what caused talks for an IMF bailout to break down last month and is making sovereign default a realistic possibility. The uncertainty has caused a near collapse of the domestic economy, with the Forint dropping to multi-year lows against the Euro and the most recent government bond auction requiring a yield of 2% higher than the one in December and still remaining undersubscribed.

Hungary is not even part of the Eurozone, but that has not stopped the fear of contagion from making investors dump EU government bonds and the Euro itself. The constant string of bad news coming out of the EU has made everyone nervous to the point of selling first and asking questions later - somewhat similar to the way the Asian Crisis of 1997 engulfed good and bad economies alike. This panic has taken EURUSD down to levels last seen in Sep 2010. At the same time the speculative futures positioning on the pair is at an extremely bearish level, so a short covering may be overdue.