This week has seen the markets calm somewhat as Trichet soothed the short term traders with upbeat comments, and avoided putting his foot in it as he did in the previous months ECB press conference. However, whilst there was little else he could do but talk up the Euro, the economic and political headwinds suggest that little has changed. In fact, the lack of the Central Banks realization that debt deflation and not inflation is the problem moving forward, and the German political reluctance (understandable) to bail out the rest of Europe, means that the Euro’s woes can reignite at any time. As mentioned previously, the devaluation will benefit Germany the most as has been seen by the beginnings of impressive export numbers. Unfortunately it has come far too late in the cycle to help the more struggling nations, even allowing for the fact that devaluation is simply a one off benefit. This can be seen in the U.K’s poor manufacturing numbers this week. The sudden reversal from Government spending to huge cutbacks will see the Euro zone slide back into recession in the 3rd and 4th quarters. More worrying still, is the fact that the ECB is likely to continue to resist an aggressive policy of quantitative easing in such an event. It can be rightly argued that even if they were to embark on such a policy it is now too late. Yields of Government debt remain elevated outside of Germany and with the economic slowdown almost inevitable in the peripherals, it could be viewed as throwing good money after bad.
This brings me to the proposed Bond EU 700 billion loan guarantee announced last week. I won’t repeat the details but one part stood out above all others. The vehicle for the process will be a “Limited Liability Company”. The last time I checked the whole purpose of having a limited liability was it meant you could walk away from those liabilities. It hardly inspires confidence and suggests that it is simply an exercise in trying to massage perceptions in the hope that you don’t actually have to do anything. Professional colleagues I have discussed this with all came to the same conclusion that it was simply smoke and mirrors. Any sign that that stresses are rekindling will in all probability see the fragility of such a program made starkly clear.
So what does it mean for the Euro? A have little interest in either a politician or central banker talking a market up, as this usually simply provides opportunities for day traders. It does nothing to address any of the big issues. Therefore, whilst the Euro/Dollar stays below 1.2265 it is under pressure in the short term, whilst on a more structural play, a long term decline through the second half of the year is the most probable outcome.
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