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Breakup Risk and the Euro

With talks underway in some countries about the merits of staying in the euro, this strategist says it's time to price in a breakup.

Sure, expectations for the European Union summit are low, and yes, there could be movement on some of the stubborn challenges facing the euro zone. But still: euro at nearly 1.25?

David Woo, head of global rates and currencies research at Bank of America Merrill Lynch, thinks it could be time to reassess.

If European leaders fail to take steps that boost confidence in the market, he adds, "I think the market will have to start thinking about breakup risk."

Woo is especially concerned about recent political developments in the euro zone, he says. "In Italy, in the last couple of week, there is now an open public debate about the cost-benefit of remaining in the euro." That's dangerous, he says, because "it's a Pandora's box. Once you open it, it's difficult to close."

Woo says he would be "very surprised" if the euro simply ceased to exist, but he thinks there is a very good chance Greece will exit. At the same time, he is watching to see whether countries like Greece exit, leaving a stronger currency, or if countries like Germany check out, which would likely weaken the euro significantly.

Uncertainty is quite high right now, Woo says, and people are talking about a breakup as an important tail risk, "but nobody basically factors it in as a central scenario."

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