I admit it. Back in May and June I repeatedly cried wolf over the Death of the Euro. Euro Crisis 1 was diverted shortly after, temporarily. Now that EC2 is flaring up, I think it's a false alarm and will blow over soon, for the short term.
EC2 is Europe's answer to QE2. The relentless rise of the Euro in October was surely hurting the Eurozone. Germany may have been cushioned somewhat by the intra-Eurozone trade, but the others have been hit by the double whammy of sluggish domestic demand and rapidly disappearing export/tourism. In this sense, EC2 is real. But regardless, the Eurozone desperately needs an excuse to devalue the Euro. Either that, or the market needed an excuse to take a pause from USD devaluation and take some profit.
Even if the above sounds a bit conspiracy-ish, it doesn't matter. What's stopping the European Central Bank (ECB) from extending their solution to EC1 this time? Nothing. If they were dead-set to keep the Euro alive back in May, then nothing has changed enough for them to change their mind now. I'm still very skeptical on the Euro's long-term survival. But for the short-term, there's no chance EC2 would kill the Euro.
On the other hand, as deliciously coined by the good folks at FT Alphaville, QE2 is already working; in fact, it worked before it started. Inflation is impossible to miss in everything except housing, which doesn't have any real impact on anyone renting or planning to buy/sell houses.
I think the market's reaction to China's tightening is also overdone. The risks in China are between high inflation and a slow-down, not crash. It's true that the profit margin for Chinese manufacturers in general is razor thin and vulnerable to a rise in commodity prices. But commodity prices have been much higher before, and for much longer. Throughout the 1998 Asian crisis, and the persistent rise in the Renminbi since 2005, Chinese manufacturers have repeatedly proven they have many more resources and pricing power than the world gives them credit for. Yet, the world continues to insist on logical deduction in the face of such glaring empirical evidence that the logical deduction is wrong. And don't get me started on the western mainstream's ignorance and misconception on most anything Chinese, like General Tso's Chicken...ok, another time.
I maintain my verdict that QE2 was ill-timed and very unnecessary, resulting in a very high risk of inflation before it's politically possible to attack it. It's a classic case of the tail wagging the dog. An overheating economy brings out inflation; but you can't force the economy and employment by artificially creating inflation. If you try, the result will be just the bad part of inflation, namely destroying people's savings and disposable income, especially for those at the lower part of economic ladder.
So, if you're long the USD and/or short the EUR for last week, congrats and consider taking some profit. Otherwise, look beyond the day/week and look ahead -- this could prove to be a good opportunity to get in on the cheap in short USD and go long the Fed.