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The U.S. dollar is narrowly mixed. Consolidation still appears to be the main feature, though sterling and Australian dollar and Canadian dollars have marginally extended recent gains. In contrast, the euro recorded a new low for the week. The next level of support is seen near $1.2380.

A further decline in Chinese CPI (1.8% July vs 2.2% in June) and a series of softer than expected data fanned hopes of new near-term easing of policy which in turn help buoy Asian equity markets and the MSCI Asia-Pacific Index rose about 0.75% to a new three-week high. European bourses are marginally higher, with financials among the strongest sectors. Debt markets are quiet.

In addition to the Chinese data and BOJ's widely anticipated decision to leave policy on hold, there were a number of other economic reports to note, even though the impact on prices may have been marginal .

First, Australia created 14k jobs in July, slightly more than expected and enough to ease expectations for a rate cut next month from about a 50% to 33%.

Second, the U.K. reported a considerably larger than visible trade deficit of GBP10.1 bln, which is about 20% larger than the market expected. Most of the deterioration took place with non-EU partners, even though recently sterling was trading near 3.5 year highs against the euro. Exports slumped 7.4% while imports fell 0.2%.

Third, Italy reported a June trade surplus of 2.5 bln euros, which is more than twice the May surplus. The trade deficit for H1 stood at 85 mln euros. June was the third consecutive month that Italy recorded a trade surplus, which has not happened since 2004.

While many observers appear to believe that Draghi's proposals last week are game changers, especially now that the German government has endorsed them, we are not as convinced. On the contrary, the fact that the German government endorses those proposals should be a clear signal that it is most certainly not a game changer.

Rather than ECB bond purchases, as under Trichet, conducted at the whim of the central bank, Draghi's proposal limits the ECB's discretion considerably. There are three conditions or limits:

  • First, countries must formally request assistance.
  • Second, that request must receive unanimous support (in some countries, such as Germany, this will require parliament,or some part thereof approval).
  • Third, the country whose bonds are to be bought, must agree to a memorandum of understanding, which includes quarterly visits by the Troika. There are still sufficient checks for the creditors to ensure that the debtors are not given carte blanche.

There is a potential game changer coming, but it is still about a year off. To appreciate it one has to jettison the idea that Germany is a whole. One has to recognize that there a numerous voices in Germany. The German government is one voice among many. Merkel continues to rate high in the opinion polls personally. She does better than her party, which has lost nearly every state election over the last two years.

The recent Germany economic data warns that the European locomotive is losing its mojo. What we will learn next week with the GDP figures is whether the German economy contracted or simply stagnated in Q2. And the PMI data suggests a poor start to Q3. If the bloom does stay off the rose, Merkel may see her own support wane. This is the game changer: Regime change.

An SPD-Green alliance replaces Merkel's CDU/CSU/FDP coalition next year. The SPD has called for constitutional changes (and a referendum ) to pave the way for joint bonds and fiscal union. It is critical of Merkel for misdiagnosing the problem. It is not simply a function of the lack of fiscal discipline. That produces the wrong cures. The problem, the SPD argues is that the euro project is fundamentally incomplete. It needs fiscal and banking union, and common financial and tax policy. An SPD/Greem coalition would still robustly defend German interests, but within a more pro-European framework.

Source: Forex: Game Changers