So far the relief rally in the Euro has been feeble. Although we did recover from 134.42 to 1.3652 starting Friday through the European session today, the market then started to retreat. The bears euro argument goes like this:
Greece, along with Spain, Portugal and Italy, all need to increase taxes to reduce the deficit, and higher taxes in a recession reduces economic growth. Consequently the central banks will have to keep the liquidity high and the rates low. This means the US, with an anticipated quicker recovery, will be in a position to raise rates quicker than the eurozone bankers, goes the argument. The debate over the validity of the US growth rate has been postponed.
Part of the Greek plan is to issue euro bonds to cover their deficit prior to the collection of taxes with the new higher rates. We will watch to see how the investors regard the safety of the Greek paper when they auction €5 of 10 year notes this week. US 10 year notes are trading at a yield of 3.79% by comparison.
The US Treasury by comparison is offering $116B of US debt. In addition to $8B 30 year tips, there is $44B 2 year, $42B 5 year and $32B of 7 year notes. With the US needing to finance the deficit, we wonder why the Fed needs to increase rates, when the tremendous supply of new paper may, by itself, raise the rates.
The assault on the euro is also beginning, by those that question the legitimacy of a currency that covers a group of independent countries that exists without a central bank and a treasury. In an article written by George Soros, and published by the Financial Times entitled: The euro will face bigger tests than Greece, Soros expressed the opinion that:
The construction is patently flawed. A fully fledged currency requires both a central bank and a Treasury. The Treasury need not be used to tax citizens on an everyday basis but it needs to be available in times of crisis. When the financial system is in danger of collapsing, the central bank can provide liquidity, but only a Treasury can deal with problems of solvency. This is a well-known fact that should have been clear to everyone involved in the creation of the euro. Mr Issing admits that he was among those who believed that “starting monetary union without having established a political union was putting the cart before the horse.
So once again we are revisiting the question of the Euro's ability to function in difficult times. The super euro bears have arrived with talk of longer term values of 1.32, 1.20 of even parity with the dollar. It is not that the US is doing things right, but rather the European nations' deficit mess may be more difficult to solve than default on obligations by states such as Illinois or California.
Later this week, Bernanke is scheduled to give his Congressional testimony, although we doubt his comments will jolt the market. The most recent COT report show the large spec remaining a 56,184 contract short, a very large position. It is tempting to be a contrarian, but they have the money because they have been right, and so far they have no reason to blow the positions. While we hate to arrive late at a party held by the bears, it looks like this party is not over yet, so we prefer trading the short side.
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Disclosure: No positions