Friday, May 14, 2010
Just when it looked as though Team Europe had finally got its act together and addressed both Liquidity (via the "How Much?!" IMF/EU/ECB package of last weekend) and Solvency (via renewed fiscal tightening in Spain & Portugal and new EU rules), economic data conspires to compound Spain's problems as Core CPI just turned negative. With many governments' fiscal plans being centred around Nominal GDP, this makes an horrendous problem worse.
Cue, a return to last week's financial crisis price action with STIR Strips flattening, EUR/USD Basis widening, Bubble CDS widening, risk assets selling off and the Euro looking more offered than a night out with Gordon Brown. The news reports claiming that the only reason the bail-out happened was because Sarkozy threatened to take France out of the Euro confirm many punters' suspicions that EU policymakers are utterly incompetent and utterly un-united.
But like it or not, there IS a package and fiscal tightening is being pushed through even at the expense of growth. And though the ECB has been politicised, despite the desperate protestations of Darth Weber of the Bundeathstar, it is clearly relaxing its monetary policy and its inflation-fighting determination. So despite the fact that the Euro has fallen a long way this year, on most traditional measures it is still over-valued. Any economic textbook will tell you that this combination means the currency needs to weaken. And clearly it is. But what does that mean for risk assets?. On a basic level, the transmission mechanism is via lower European growth and lower demand from Europe, but the ECB's "no it's not QE, you are wrong" version of QE, the Fed's unsterilised FX swaps as well as lower yields and monetary tightening being pushed out further, globally, mean that at least some of this effect will be offset. And yesterday's "Mibometer" chart showed European equities decoupling from EURUSD.
The point is that Euro-weakening is not inconsistent with risk asset-strengthening. EU policy incompetence since late-last year has created a Pavlovian-dog approach to moves in the Euro being transmitted to risky assets. Provided the Euro only grinds lower, it does not provide a particularly big risk to global growth. But if the moves become disorderly then you know what to do...
...which brings us to another point. Short Euro is the "trade du l' annee" and its inability to sustain any rally have encouraged positioning to grow significantly. The other helping hand has been Macroman's beloved currency piss-takers taking a bath on all those Euros they bought above 1.50 and now selling Euros on any bounce. Without the worry of fighting FX Reserve Managers, players have felt confident both in selling rallies and selling weakness - "I ain't short enuff" is the common cry. (But then you never are are you? Right up to the point when you ARE and wished you weren't). One thing is for sure, there are some very large positions out there. And while the Euro is not significantly undervalued, policymakers purport to take a dim view of disorderly moves in exchange rates as they "pose a risk to global growth". (Right Oh). Today we see the Mibometer link is creeping back in as the speed of the sinking of the good ship Euro drags other otherwise buoyant assets down with it. This spread closing shows that we are back to a purer asset-linked panic mode and it is hard to see policymakers just sitting tight. Somewhat amusingly, Voldemort and his Death Eaters now have an interest in the EUR *not* collapsing and it may be the case that it is the G20, not the G7 that intervene. Seems eerily reminiscent of October 1998 when Macro Hedge Funds really really wished they weren't short Yen...
So as this is posted and the city echoes to the cries of "NEW LOW EURO!!!" emanating from the windows and voice boxes of FX trading rooms, the mighty currency looks like it has been relegated to a bio-fuel substitute. However, there may be a glimmer of light at the end of its tunnel: the theory that the gene pool of the "last Euro" will be preserved as a lonely specimen in a basement in Brussels, is perhaps not to be. There may be two other genetic variants to breed from in the future:
- The Euro stash to be found one day mutating in the basements of the SNB.
- The Euro DNA from EUR500 notes still being used by lost tribes in Colombia in the years to come.