After yet another weekend gab-fest by European leaders which generated a lot of opinion but no real action, the euro was under renewed assault on the first day of the new week. Evident once again was more contrasting opinions from various European officials ahead of last night’s critical conference call between Greece and their creditors. ECB Governing Council member Weidman was particularly circumspect, claiming that the planned EFSF expansion created the wrong incentives for those countries receiving aid to rectify their poor national balance sheets, and that from his perspective there were few signs of either a more co-ordinated fiscal policy or a fiscal union.
Quite rightly, Weidman opined that the July 21 agreement on the EFSF was a further step towards joint liability without any commensurate strengthening of national fiscal affairs. The single currency slipped again overnight after S&P announced that they were lowering Italy’s credit rating from A+ to A, with a negative outlook. Amongst their concerns, S&P cited Italy’s enormous debt burden, a ‘fragile’ government and poor growth prospects. Against the backdrop of renewed risk repulsion, the EUR is back at 1.36, the Aussie is below 1.02, the DAX lost another 3%, and 10yr Bund yields were another 12bp lower at 1.75%.
Guest post by FxPro
Commentary
The euro bear trap. Amidst almost universal pessimism, it is becoming increasingly rare to find anyone with anything positive to say about the euro. According to conventional wisdom, the euro is doomed because there is no fiscal union, various sovereigns and major European are either already effectively insolvent or rapidly approaching it, European decision-making is sclerotic and invariably over-ridden by national considerations, and Europe’s south is diverging rapidly (in economic and financial terms) from the north. It needs to be said that we absolutely share much of these concerns over the euro’s future, and have been voicing these worries for some considerable time. However, it is not the case that Europe’s problems necessarily translate into a super-bearish view of the euro from a directional perspective. Witness the price action over the last few months. Despite the intensification of the sovereign debt crisis over the summer, one which has morphed into a similarly troubling banking crisis, the single currency has only recently broken out of what was an incredibly tight trading range of 1.40-1.45. Even then, the breakout to the downside has thus far failed to really penetrate 1.35. Hardly a raging bear market. Also, central banks and sovereign wealth funds continue to buy the euro, especially the Asians who remain desperate to diversify out of the dollar which is being deliberately debased. For their part, the Swiss National Bank has also recently announced that they are an unlimited buyer of the euro. There is also this growing excess of adverse positioning towards the single currency. According to the latest CFTC figures, those with euro longs completely capitulated over the past three months, to the point where euro shorts are now at a 14m high. And yet, despite this very heavy selling by traders and investors, the single currency is only slightly lower over this time period. A lower euro certainly cannot be ruled out, and it remains highly vulnerable to ‘event risk’ like a sovereign debt default or more funding strife for major banks. However, the pay-off for being short the euro over the last few months has been remarkably meagre.
Call to Europe’s leaders – do something, anything. Growing international condemnation of their failure to deal with the sovereign debt and banking crisis must rank as one of the most powerful incentives for European leaders to finally bridge their differences and implement fundamental structural changes to the way that the monetary union operates. Unfortunately, signs of this occurring are still scant, despite some excellent policy advice from various respected financial commentators. In yesterday’s Financial Times, for instance, there were two excellent op-ed pieces from Lawrence Summers (now Harvard University Professor) and Wolfgang Münchau. In his article, Summers lauded the recent recommendations of Christine Lagarde, now IMF president. Lagarde’s policy prescriptions for Europe are threefold. Firstly, the financial autonomy of Europe’s sovereigns needs to be significantly reduced, at the same time as banking regulations need to be centralised. Secondly, Europe’s banking system is seriously undercapitalised, and governments must address this sooner rather than later. Finally, Europe must undertake expansionary fiscal and macro policies, at a time when growth is negligible and is weighing on fiscal consolidation. Separately, Münchau contends that the ECB that must step to the plate. More precisely, their Securities Markets Programme must be ramped up significantly and interest rates need to be lowered drastically. Even so, Münchau argues that this is not a sustainable solution, as the imbalances would persist (and probably worsen). Ultimately, in his view, Eurobonds and a fiscal union is the only escape route. However, the German Constitutional Court effectively scuppered that path, which when combined with growing political hostility towards Europe’s fiscal miscreants within Germany renders an involuntary break-up of the single currency increasingly likely. Surely, Europe’s leaders can see that bold, decisive action is now beyond urgent. Dithering, discussion and endless debate now need to be replaced by a recognition that the soundness of Europe’s financial future is hanging by a thread. Merkel needs to abandon the anti-Europeans in her party, and fast.
Dollar welcomes Obama’s new fiscal plans. Certainly a good part of the explanation for the dollar’s strength over the last couple of days is the continued failure of European officials to effectively deal with their increasingly desperate sovereign debt and banking crisis. However, the greenback has also benefitted from a fresh long-term fiscal consolidation plan announced by the US President yesterday. Obama’s new fiscal package will include more than USD 3 trln of budget savings over the next decade, including USD 1.5 trln of new revenues, USD 1.1 trln of defence savings, and almost USD 600 bn of savings in the contentious area of entitlements. Roughly half of the extra tax revenue will result from the expiration of the Bush-era tax cuts for the wealthy. This latest fiscal package from President Obama is in addition to the USD 1.2 trln of savings announced as part of the debt ceiling agreement. As always, it needs to pass through a fractured Congress. Separately, the Joint Select Committee on Deficit Reduction is scheduled to submit their proposals for reducing the fiscal deficit by November 23rd. Their mandate is to lower the deficit by USD 1.5 trln over the next ten years. If the majority of committee members agree on a package, then it needs to be voted on without amendment by both the House and the Senate before December 23rd. If there is no agreement by the Committee, then USD 1.2 bn of automatic across-the-board budget cuts would be triggered. Although these announcements on taming America’s fiscal obesity are to be welcomed, it is not easy to square them with the short-term stimulus plan recently announced. Surely, more stimulus now, against the backdrop of a stalling economy, rising unemployment and an ageing population, must render the start-point for long-term fiscal consolidation much worse in the future. Delaying the pain just makes the suffering even greater.
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