Fundamental Forecast for the Euro: Bearish
- Portugal’s Sovereign Credit Rating is Cut to Junk at Fitch
- Staying Short Euro vs US Dollar, Aiming for October Low
- Speculative Sentiment Hints Euro is Likely to Fall Further
- Germany Talks Down Market Hopes for a “New Bazooka”
- Bundesbank Cuts Growth Outlook, ECB Rate Cuts Ahead
The Euro hit the lowest level in nearly two months last week on approach to the year-to-date low at 1.3146 against the US Dollar as the Eurozone debt crisis continued to fester. The news-flow has been nothing short of dismal, with Portugal and Belgium getting downgraded by Fitch and SP respectively while Greece reportedly picked a fight with its creditors over an upcoming bond swap meant to relieve its debt burden (to say nothing of the German 10-year bond auction fiasco). These are all minor issues however relative to investors’ true concern, that German intransigence will doom the single currency.
The abject failure of Eurozone politicians to meaningfully contain the spread of the debt crisis up to this point is arguably a foregone conclusion. Despite countless summits producing “comprehensive” remedies over nearly two years, officials have proven themselves unable to convince the markets that they are truly serious about sovereign risk. As many (including ourselves) have argued for some weeks now, the only two options this late in the game are joint Eurobonds – a setup that would effectively allow healthier core countries to co-sign loans to their debt-strapped brethren – or an aggressive bond-buying program from the European Central Bank to hold down regional borrowing costs and buy time for structural reforms.
Germany has been quick to reject both options, claiming Eurobonds will allow profligate countries to side-step reform with impunity while an ECB version of quantitative easing will unleash inflation. Admittedly, the Eurobond option is not a great one. Looking past the moral hazard argument, such a scheme would practically take a long time to set up, and time is not something that Eurozone politicians have in surplus at this point. On the other hand, if the ECB were to be given the green light to enter the fray as a true buyer of last resort for member states’ bonds, it could do so quickly and provide immediate relief. Indeed, the inflation implications of such a move seem hardly problematic now as slowing growth bears down on price growth, so if ever there was time to print money than this is it.
With all of this in mind, the spotlight in the week ahead will turn to a two-day meeting of Euro area finance ministers starting in Brussels on Tuesday, with ECB involvement in containing spreading turmoil likely in focus. Indeed, if policymakers emerge out of the sit-down with another half-baked proposal akin to what was announced in October, traders are unlikely to respond favorably. Against this backdrop, a long list of countries including Italy, Belgium, France and Spain are set to hold bond auctions, giving EU politicians a real-time reading on traders’ assessment of their efforts via yield levels.
If Berlin’s administration is ready to meaningfully deal with the crisis, it can sell ECB involvement to their population as a bulwark against deflationary pressure amid slowing growth rather than a bailout (which would not be entirely dishonest considering the sharp slowdown in headline CPI being forecast for 2012). It would be wise for Germany itself, for as an exporter it would benefit from saving the single currency while driving down its value. The rest of the Eurozone is best to press and pray for just such an outcome.
