Casts Doubt on Growth, Interest Rates and Financial Stability of EU, Global Economy
EURUSD DAILY AVAFX CHART 07 FEB 12Summary
Euro Outlook: Bearish
- Events: Tues- German ZEW Sentiment, EZ ZEW Sentiment, Wed- EZ Construction Output, Trade Balance, Thurs- EZ Consumer Confidence Fri-German PMI Manufacturing, Services
- Judgment Day Approaches:Greece needs about € 30 bln just to pay off maturing bonds in April and May, about € 7 bln in its treasury – default likely to quickly spread to all PIIGS block, risk credit market seizure for government bonds, market crash
- The EU has no clear plan to deal with Greece and rest of PIIGS block debt
- Weak 4Q GDP readings add another burden to the euro
- EURUSD’s steady, descending trend channel to continue until substantive solution for EU debt mess
- A number of solutions are possible, but all realistic ones are complex and painful
Just six months ago, the euro was prized as the primary alternative to the US dollar (a currency that has fallen from grace since the financial crisis). Today sentiment has shifted against it:
- There is little sign of a rate hike from the ECB on the horizon for fear of sinking its weakest members
- There is a widely divergent picture of economic health and needs among the EU members, and the EU has yet to show it can survive a significant economic crisis that exacerbates these differences, and thus…
- The very stability of the European Monetary Union has been thrown into doubt.
- There remains less than 12 weeks for Greece to raise about € 30 bln to pay off maturing bonds or default on them, likely causing the rest of the PIIGS block to be unable to sell bonds and quickly send most of Southern Europe into default or impending default.
The Euro has suffered the most dramatic reversal of any of the major currencies; and yet this dire fundamental backdrop is not fully appreciated. In the week ahead, the market will keep its focus on the Greece to see whether EU officials can rescue an economy that is quickly fading without evoking severe side effects along the way. That growth appears to be slowing in the EU’s strongest economies appears to be the least of the EU’s concerns.
There are a few approaches the European Union can take to defuse perhaps the greatest threat to its stability in its relatively short history. However, there is no scenario that does not come with a significant potential for failure. Here are a few of the obvious ones:
- The first option (and the most ideal for policy makers) is to hope markets will essentially continue to trust Greece’s creditworthiness based on mere verbal assurances about Greece’s stability from the EU and Greece, and depend upon market sentiment to improve on its own. Given that Portugal has already had a failed bond auction and the neither the EU nor Greece has shown anything close to a real solution for Greece of the rest of the PIIGS block (which will be expecting similar support for their even larger debts), this option is simply unrealistic.
- That a single economy or the EU group could extend a lending facility that will ensure against default and buy the economy time is almost as unlikely. First, it raises the ‘moral hazard’ issue. Other member economies will see that they will be bailed out should they breech the EU’s guidelines. And, there are more than a few members that could use aid right now and will almost certainly need it should conditions continue to deteriorate. Secondly, even the strongest economies in the EU are not healthy and any leader that pledges to send funds needed at home to subsidize mismanaged economies is likely committing political suicide. Thus Germany’s recent refusal to even discuss a bailout.
- The more complicated and ominous scenario would be for Greece or another member to eventually secede from the Union. This is a more unlikely scenario; but there are those that believe that this is ultimately inevitable. The Economic and Monetary Union is little more than 10 years old and already major problems have developed. Common monetary and fiscal guidelines designed for stronger economies simply do not fit economies Greece, Portugal, Spain and others are in their current state, which instead need to print money, raise their debt to GDP ratios, devalue their currencies to make their labor and exports cheaper and reflect their lower living standard. Barring a major infusion of aid, that is likely
- As we’ve noted in Stocks, Forex, Commodities Outlook 2/15—2/19: EU Debt Crisis, Other Market Movers, and in Southern Europe Will Not Be Allowed To Default, the final and most likely outcome is that EU leaders convince the rest of the world to share the financial burden of a PIIGS rescue plan in order to avoid risk of global collapse and damage to sovereign bond markets everywhere. This depends on whether the PIIGS will accept effective loss of sovereignty as they are placed under some kind of trusteeship to ensure donated funds are properly managed. However, it is far from obvious that they would except such a deep blow to their national dignity and such a dramatic drop in living standard that any austerity plan would likely impose
Any of these will take time to develop once/if one of them can be agreed upon, and April is not far off.
Make no mistake: the EU debt crisis (Greece is just the beginning) is THE dominant threat to the current fragile global recovery and dwarfs all other market drivers at this time.Events
News surrounding the resolution of this crisis, or lack thereof, is likely to dominate market sentiment and thus drown out most other news or regularly scheduled economic news releases.
The top market movers are the ZEW survey figures and the PMI activity figures
DISCLOSURE: LONG USD