Is Europe’s mantra changing?

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It’s Monday and the shifting sands of the European mindset are moving (not for the first time) towards the issuance of common bonds as a means of overcoming the sovereign crisis. This is one of the changes in momentum that has emerged from the weekend’s meeting of G8 leaders, together with giving the EFSF the ability to re-capitalise banks.

It’s a sign that there is stronger desire to see an alternative to the hard-line German stance of austerity, with few after-thoughts. Furthermore, the German Chancellor will find it increasingly difficult to resist this shift, especially when it is being endorsed at the international level.

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The wider issue is that at no point have European leaders really seized the initiative on the crisis, compromising by doing just as much as they believe necessary to stop things getting worse, rather than going all in to turn things around. Imagine where we would be if Greece had restructured its debt back in May 2010, a decent firewall was set-up and a shift towards common bonds was put into train. Most likely, we’d be in a better place than we are now. The single currency recovered on Friday, despite the weaker tone to stocks. This is partly a function of the extent of the short-positioning that has built up in the single currency, which could mean that a push below the year’s low at 1.2624 could prove a little tougher than some expect.

Commentary

Record euro shorts. The weekly CFTC data on currency positioning showed speculative shorts on the euro at record levels which, to a certain extent, explains the price action seen on Friday, when some market action (stocks) was suggestive of investors reducing risk, but FX markets seemed to suggest otherwise. The extent of short positioning is not that much of a surprise given the recent headlines surrounding the eurozone crisis, but does make for tougher trading conditions ahead as positioning becomes an ever more important factor in explaining the prevailing price action.

Aussie down the elevator shaft.  After last month’s arm-wrestle which saw the AUD reach almost 1.05, the currency has been constantly on the back-foot over the past three weeks, falling through 0.98 to a 5mth low in early London trading Friday before some consolidation and profit-taking by successful shorts ahead of the weekend.  Numerous factors contributed to this latest burst of bearishness. Obviously the continuing uncertainty over just when Greece will leave the euro and the contagious effect this is having on the likes of Spain and Italy is weighing very heavily on risk appetite. Also, the news that emerged out of China overnight reaffirmed that the economy is experiencing a much tougher time. Home prices last month fell, compared with a year ago, in 45 of 70 major cities, and car dealerships apparently are increasingly clogged up with inventory they are unable to clear. More and more commentators are lowering their growth estimates for China although, on the positive side, there is increasing speculation that policy officials in Beijing will soon sanction another easing of monetary policy because the economy has clearly deteriorated further in the current quarter.  Furthermore, local banks down under were spanked after remarks made by the CEO of ANZ; he claimed that international funding markets had dried up again as a result of the Greek debacle. Another story doing the rounds which hurt the Aussie was that Chinese mills are apparently postponing delivery of iron ore because of slowing demand from the world’s largest consumer of steel. Right now, it is difficult to fight the price action, although the bears need to keep in mind that the Aussie is extremely oversold.

Spain’s juggling act. Notwithstanding incredibly perilous financial circumstances, the Rajoy government deserves credit for its determination to attempt to steady the Spanish ship. Last month, the law was changed in Spain to allow the central government to intervene in the fiscal affairs of the previously very independent regional governments. However, the latter have been unable to access funding in the capital markets, forced therefore to accept guarantees and other types of financial assistance from the central government. The aim is to reduce the overall budget deficit in Spain to 5.3% of GDP this year, although the way the economy is floundering it may well be that the fiscal shortfall is nearer 7%. Despite best endeavours, it is abundantly clear that the recession in Spain is worsening. According to the Bank of Spain, non-performing loans rose to 8.37% of total lending in March; apparently bad loans rose by an incredible 90% in the year ended Q1. NPLs in Spain now total EUR 147bn. Little wonder that Moody’s decided to downgrade 16 Spanish banks last week. Unfortunately, the financial holes appearing in Spain are becoming cavernous.

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