More Bad News For The Euro

Includes: ERO, FXE, GBB
by: Kathy Lien

The euro ended the day unchanged against the U.S. dollar, which is surprising considering that Europe's problems continue to grow. While Spain had no issue attracting demand for their short-term bills, investors required significantly higher yield to be willing to own Spanish debt. With interest rates on three-month bills tripling since May, investors are clearly nervous about being exposed to Spain, even on a short-term basis. Normally this would be terrible news for the euro, but the currency took the results in stride. The EUR/USD also shrugged off a downgrade of Germany's sovereign debt rating by Egan-Jones, the small but extremely respectable rating agency.

At the same time, shockingly brash comments from German Chancellor Merkel and Italian Prime Minister Monti also had very little impact on the euro. The currency pair's resilience in the face of bad news reflects the lack of interest in one-sided positioning ahead of the EU summit. In other words, any one who wants to buy or sell euros before the meeting already has their positions on and the rest are waiting on the sidelines until the EU statement is released. All the side meetings that are happening before the summit have fueled hope for a positive outcome -- eurozone Finance Ministers will be gathering again tomorrow over teleconference.

Yet a satisfactory outcome from the summit is becoming increasingly unlikely following public spats between European leaders. This morning, Merkel said there will be no shared debt liability for as long as she lives, which is an extremely strong statement that leaves zero room for ambiguity. Every opportunity she gets she publicly opposes any type of liability-sharing, and with only 48 hours to go before the summit begins, there is simply not enough time to change her mind. The lack of compromise from Merkel has made European leaders extremely frustrated. So much so that there was apparently a story today in an Italian newspaper that said Italian Prime Minister Monti threatened to quit if Merkel did not relent on eurobonds. While the story was later denied by Monti's administration, it nonetheless reflects the deep-seated frustration among European policymakers who know that little will come out of the summit other than a plan for growth and a tax to raise bailout funds. For this reason, we expect the EUR/USD to remain under going into Thursday's meeting.

Amidst all these euro negative developments, there was one piece of good news. According to GfK, German consumer confidence increased for the first time in five months. Concerns about the region's debt crisis were outweighed by higher wages and the improvement in the labor market. However, with manufacturing and service sector activity slowing in the eurozone's largest nation, it is hard to believe that these wage gains can be sustained. The ECB still needs to ease monetary policy this year and how quickly they act will depend on the market's reaction to the EU summit.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.