Euro rallies 2% on optimism about Europe

October 10, 2011: 10:57 AM ET

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NEW YORK (CNNMoney) -- The euro rallied more than 2% Monday after European leaders said they'd unveil a plan to solve the European debt crisis by the end of the month.

Over the weekend, German Chancellor Angela Merkel and French President Nicolas Sarkozy said they have come up with a plan to get Europe's festering debt problems under control.

The plan, which will include recapitalizing European banks, will be presented to world leaders at the G20 meeting in Cannes Nov. 3 and 4.

The euro shot up 2.1% to $1.36 in early trading Monday.

The mostly steely euro has taken a beating in recent weeks as investors become increasingly wary about what a Greek default could mean for European banks and for other nations in the European Union.

But whether Greece defaults on its sovereign debt, as predicted, in an orderly or disorderly fashion, analysts and observers agree that the European Union is likely to stay together. As painful as it might be in the short- or even medium-term, all of the 17 nations that use the euro are expected to keep using the currency.

"The risk of someone leaving the euro is a small tail risk probability," said Dan Dorrow, senior vice president of research at Faros Trading, an independent currency broker-dealer.

And as long as the current members of the EU stay on the euro, the currency should ultimately resume its upward march.

What's weighing on the euro in the near-term is speculation that not only Greece, but Italy, Spain, Ireland or Portugal could flee the euro to bolster their economy.

All of those so-called PIIGS have been struggling with potentially crippling sovereign debt problems

Don't expect a euro breakup ... yet

Historically, countries facing similar sovereign debt problems have the option of trying to devalue their own currency to sell more cheap exports and to lower their debt burden.

Proactively devaluing the currrency isn't an option for the euro since it's impact would be felt by 17 different countries.

"The system will hold together but it will not be a stress-free exercise. The benefits of keeping Europe and the euro together outweigh the risks over the long-term," said James Rickards, senior managing director at Tangent Capital Partners. "What's going on in Europe is classic brinksmanship."

That brinksmanship could spell sharp day-to-day swings for the euro and cause a schizophrenic investing environment for anyone looking to bet on currencies over the next few months.

Merkel stokes bank rescue speculation

This week, German Chancellor Angela Merkel and other European leaders reiterated a commitment to providing funds to help struggling European banks, if needed, to prevent a broader financial crisis. Still, the terms of how much money the EU might provide and how quickly it could be disseminated hangs in the balance.

Compared to Europe, the United States actually has the tools and the political will to push down its currency, even as Congress prepares to fight back against what it calls Chinese manipulation of its currency, the yuan.

"It's an unspoken channel of Fed policy," said Dorrow. "It's one of the key levers that's still available to the U.S."

Pushing down the value of the U.S. dollar in relation to other currencies is one of the few ways President Obama can achieve his 2010 State of the Union goal of doubling U.S. exports by 2015."In the U.S. we are clearly on a path to weaken the dollar to promote exports," said Rickards.

Any devaluation of the U.S. dollar would have an inverse effect on the euro.

Since late August, investors have traded out of the euro, causing its value to drop against the dollar. This week however the euro changed course and jolted upwards as investors grow more hopeful that the European Union can resolve its problems.

"I think the price action is telling you the market is short euros," said Troy Rohrbaugh, head of global currency trading at JPMorgan Chase. The euro gained 0.5% to $1.35 Friday.

Recently, the global currency trade has become largely a game of deciphering which country or region offers the greatest near-term risks and moving away from that. Traders said that investors are literally trading away from the worst currency for the day.

"Over the long-term, for the euro to make significant gains, you need a resolution in Europe," said Rohrbaugh. To top of page

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