The ECB increased interest rates last week by 25 basis points in an attempt to remove excess stimulus from the system and try to stay ahead of inflation, running at 2.7% against the 2% target, before it becomes systemic. The downside to this move puts additional pressure on the PIIGS, especially Greece and Italy, to get their collective houses in order.
The results from the new EU stress tests will be released on Friday, July 15th. Those banks that fail the tests will be required to raise additional capital in the next six months or sovereign governments will step in to recapitalize or restructure the banks in question.
The ECB also leaked to the press that around 26 banks will need to acquire additional capital after the most recent stress tests which do not take into account sovereign default.
Given the problems in Greece that have the potential to spread to Italy it is incumbent upon the EU to head off this potential crisis quickly or succumb to it spreading across Europe.
The new Portuguese government has accelerated austerity measures in order to meet deficit reduction targets set out in its bailout by the European Union.
This made Portugal’s downgrade more of a surprise to the markets and it upped the pressure for everyone to work out the Greek problems.
In response, the ECB announced that they will be suspending collateral requirements for Portugal in an attempt to stop problems from Greece spreading to Portugal.
The rate increase mentioned earlier puts the ECB and EU between a rock and a hard place. The ECB has a single mandate, to keep inflation low and the most recent figures put inflation at 2.7%, well above the 2% limit. If the ECB holds the line on interest rates they risk inflation becoming systemic and spreading to wages as German and other unions demand higher salaries.
The EU and the ECB are caught between the rock of systemic inflation or the hard place of contagion from one of the EU smallest countries both spreading across the European continent.
This bodes well for the US Dollar, which is poised for a breakout, as market participants are beginning to realize that the only way to bring the PIIGS out of trouble is to depreciate the EUR hopefully kickstarting export growth in the trailing countries.
Investors looking to play a potential collapse of the Euro and Pound can look to a number of ETF’s in addition to Gold (GLD), (DGP) and Silver (SLV), (AGQ).
Investors looking to short the Euro have 2 choices available, the ProShares UltraShort Euro (EUO) and the Market Vectors Double Short Euro (DRR). Both funds use futures to replicate a short position equal to 200% of the inverse move of the U.S. dollar against the euro.
If you wish to go long the U.S. dollar as a play on its safe haven status and ahead of a budget deal between the President and Congress investors have two options, the PowerShares DB U.S. Dollar Index Bullish Fund (UUP) and the PowerShares DB 3x Long U.S. Dollar Index (UUPT).
Disclosure: I am long SLV, DGP, UUP
