In Europe, which I believe will survive despite all of the problems, much to the chagrin of ex-currency traders, companies will be looking for a new supply of cheap labor as transportation from Asia becomes increasing expensive due to higher commodity prices. On the other side of the Mediterranean lies a new political landscape and governments looking to increase employment.
Irish banks are moving towards another bailout, as stress tests are showing a need by the top four banks to raise an additional $24 billion in euros, merge, and sell off assets in order to strengthen balance sheets.
Portugal is being dragged kicking and screaming towards an eventual bailout, as is Spain. Both countries are trying to restructure and move towards a solution which will not require a bailout, but we are likely to see some sort of negotiated assistance as the ECB has started a rate tightening cycle.
In Trichet’s introductory statement after yesterday’s rate hike, he used the term "monitor very closely," which indicates another rate hike coming in two to three months, depending on incoming data. The worry is that HICP inflation (2.6% in February) is coming in higher than the Governing Council’s goal of 2% over the medium term. Looming in the background is the end of Trichet’s term which will be coming on October 31.
Right now the markets are trying to push the head of the Italian Central Bank, Mario Draghi, as the next head of the ECB. This decision will likely depend on who heads the ESEF. Rumors are floating that the head of the ESEF will be pushed towards an inflation hawk while leaving the ECB head for a more moderate candidate, which would be positive for Draghi.
Further complicating matters is the lack of a French representative on the ECB board while there is an ex-Bundesbank member. This plays into internal ECB politics and may signal that Trichet will have a greater hand in choosing his successor than most believe in wanting to keep some French influence on the board as a counter to Germany.
The quicker elections are held in Germany, the worse the outcome for the Merkel government. It appears as though everyone is jumping ship, with poor election results in key strongholds and the recent resignations of Bundesbank head Alex Weber and coalition partner Guido Westerwelle. If Merkel can push blame onto the others, there is a chance her government survives this leadership test.
Germans are angry over their funding of PIIGS bailouts. A snap election would be disastrous for the Merkel government and likely lead to a more hardened negotiating stance with the PIIGS. Depending on the stance, this could be either very good or bad for the markets.
The failure of Amagerbanken A/S in Denmark may be foreshadowing the future for the PIIGS, where bondholders will share in the losses with sovereign nations and taxpayers. If the bailouts and restructurings continue, there is a greater chance for bondholders to eventually share in the pain being felt by sovereign nations and taxpayers.
The European exchanges are still trading below highs made earlier this year as a number of uncertainties are clouding the post-Japan market recovery. There are talks of bailouts and restructurings in Greece, Portugal, Spain, and Ireland, protests in the U.K. as austerity programs are being implemented, inflation beginning to kick up across the board, and problems in Germany despite strong economic growth.
Given the uncertainty surrounding the EU, it would be advised to remain on the sidelines for the time being, as the macro picture is clouded at present. The only stock I would advise looking at is AS Premia Foods, trading on the NASDAQ OMX Tallinn Stock Exchange as a play on the potential for problems with fish farmed off the coast of Japan.
Because of all the problems surrounding the PIIGS, I would prefer to be long the U.S. dollar versus the euro, as the EU needs a weaker euro to help the problems with the PIIGS. A stronger dollar would slow growth in the U.S. while increasing interest rates and keeping a lid on inflation in Europe.
To that extent, I would look to go long the PowerShares DB US Dollar Index Bullish ETF (UUP) and Gold (GLD, DGP) with gold only through April, as May is seasonally a weak month for gold and a resolution for the problems in Portugal, Ireland, and Greece would be bearish for gold over the spring and summer months.
Disclosure: I am long DGP.
