The Way to Play the Cyprus Crisis, Buy This Currency
Uncertainties surrounding the Cyprus bailout are set to continue for some time, but one way to play the fallout is to buy the Australian dollar, one analyst told CNBC.
Since news of the Cyprus bailout first broke in mid-March the euro has been under pressure falling against the U.S. dollar, as renewed fears over the euro zone crisis resurfaced and unsettled investors.
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According to Chris Weston, chief market strategist at Melbourne-based trading firm IG Markets, the optimal way for investors to play the crisis in the short-term is to invest in the euro/Aussie dollar currency pair.
"The euro/Aussie looks a good way to play the concerns," said Weston. "This is because we believe the euro will continue to weaken, and secondly because the best way to express that weakness is against a higher yielding currency like the Aussie dollar," he said.
There is evidence of this trend gaining traction, according to Weston. The euro has fallen around 5.3 percent against the Aussie dollar since early February, suggesting investors are ditching euros and buying the Aussie dollar.
(Read More: Aussie Dollar at $1.30: Are You Kidding?)
Weston expects the euro to continue on its downward spiral as nervous investors consider parking their cash elsewhere, making the euro/Aussie dollar pair even more attractive.
Cyprus and its international lenders struck a last-minute deal on Monday to help rescue the small economy's struggling economy. The terms of the proposed deal involved a levy on uninsured deposits over 100,000 euros ($127,842) in the Popular Bank of Cyprus - known as Laiki - which is set to be wound down. The move has prompted panic among investors, who are now worried a similar template will be used for other European economies.
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"There is a possibility that people in Spain, Italy and France with sizeable deposits will consider taking their money out and moving it to the U.K, U.S. or Australia. These flows out of Europe will lead to continued weakness in the single currency," said Weston.
The optimal way to play this trend is to buy the Aussie dollar, said Weston, because Australia is the highest yielding currency among G-10 economies.
Australia's interest rates have held steady at 3 percent since December 2012 and most analysts agree its central bank will not move to cut rates in the near-term. Meanwhile interest rates in other major western economies like the U.K., the U.S. and the euro zone remain at record lows of less than 1 percent.
"Traders who are shorting euros and going long the Aussie are also getting the benefits of the carry trade, where essentially they are being paid just to be in the trade even after the adjustment of inflation," added Weston, referring to the trade where investors borrow money at low interest rates in order to invest in higher yielding assets.
Adding further impetus to the trade is the fact that the euro/Aussie dollar currency pair has hit some critical technical support levels in recent weeks, said Weston, including 1.2264 on Tuesday, meaning a move to 1.2160 against the Aussie dollar was now possible. On Thursday the euro was trading around 1.2257 against the Aussie dollar by midday in Asia.
"The euro/Aussie pair has been oversold to an extent, but it is in a firm downtrend and has closed below some key technical support levels," he said.
However, a risk to this trend will be the danger of too many traders coming to the party, added Weston.
"When too many people are short the euro, you get a lot of short covering, which pushes the price up," he added.