I found no particular reason to treat the joint central bank initiative as a departure from the usual euro narrative – somebody placed somewhere high talking up the market every now and then to engineer short, targeted gains in the single currency. If anything, doubts about the Dec8&9 summits pressured the euro down again on Friday, as time to back words with actions drew near. Seen closely, the surprise market rally of last week betrayed more investor desperation than confidence in the troika’s ability to deliver as efforts to save the euro effectively run into overtime.
My crystal ball agrees more with Morgan Stanley than BNP Paribas, that rather than some manner of sanity returning to the euro argument, the recent rally provides a fresh position to renew shorts. According to Bloomberg, futures traders have increased bets the euro will fall against the dollar, with net-short wagers rising the most since June ’10. So, even as the last five trading days marked the euro’s first weekly gain since Oct 28, I see little to believe near term strength in the European currency. Its failure to break above the 1.3560 resistance confirmed my hunch that the talk-up would subside as forcefully as it materialised. Remain committed to the 1.30 drop. It shall come.
It is actually quite simple to rationalise. One, whether made directly, channeled through IMF or made as a Christmas present by Santa Claus, Europe’s financial firepower is simply insufficient to neuter sovereign debt bombs. Two, fashioning the ECB into an endless lender of last resort will mandate running printing presses overtime, un-bottling inflation expectations and driving Germany even farther from the rest. Three, this week’s interest rate conclave will only deepen the cleavage as the expected 25bp cut will feed Bundesbank paranoia of inflation. There is already rising unrest in Germany as rising prices threaten to undermine the middle class’ savings, infuriating the biggest vote bank. Four, countries (like Italy, Portugal, Greece) expecting Germany, and the international community, to step up funding will not register meaningful growth as harsh austerity compromises productivity and eventually growth, requiring unending exogenous support. Five, the road to fiscal union will concentrate unprecedented political decision making in Germany, contrary to the original founding intent of the union. No sir, there is no way the euro can survive this crisis unscathed. Best case scenario? Deep, protracted recession. More likely? Unravelling of the single currency. Near term scenario? Drop to 1.30!
Interestingly, Europe’s drama is no longer restricted to the currency market, its fear-and-greed pendulum swinging visibly into the oil market as well. If it hadn’t been for geopolitical uncertainties bidding up crude, oil too would have swung endlessly up and down as emergence and redressal of contagion fears in Europe impacted overall aggregate demand. But so long as Israel threatens attacking Iran, Tehran vows blocking the Straits of Hormuz, Saudis sweat over the shia uprising in the eastern provinces, Libya struggles with regaining Qaddafi era production levels and the Arab spring sprouts Islamist governments, oil will remain elevated. Ditto for oil and commodity currencies.
Be prudent, posture for shorts against commodity currencies. Stay away from mainstream market currents till this week puts the risk environment in perspective. The euro summits and interest rate decisions are the last roll-of-dice by euro zealots. And even if they throw in the kitchen sink, they simply would not have enough funds to forestall imminent falling sovereign dominos. Wait till the market prices it in. Till then, trading euro-dollar is like catching falling knives.
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