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Storm Clouds Continue to Mount for Troubled Euro

Tuesday, 15 June 2010 05:49 PM Current | Bio | Archive

Now that it’s clear to most investors that what's going on in Europe — and with the euro — is what’s moving global markets, let’s take a “technical look” at the euro itself.

Having closed back above $1.2130, there is the possibility that the euro might now find its way back to the 2009/08 lows against the dollar (which were $1.2453 and 1.2332, respectively) in an atmosphere of somewhat reduced pessimism.

However, investors shouldn't overlook one notable risk event this week that possibly stands in the way of the euro’s extended reprieve: the EU Summit that starts Thursday and concludes Friday.

We should keep in mind that the EU sovereign debt crisis is still smoldering despite EU leaders focusing on the future framework of Economic and Monetary Union.

But there are no plans for fiscal union that European Commission President Manuel Barroso and IMF Chief Dominique Strauss Kahn have advocated as an essential accompaniment to monetary union.

In fact, the future “improved” framework of the European Economic and Monetary Union faces some kind of a non-starter status because of the German constitutional constraints.

Officials will present a “progress” report to the summit on plans for a new improved version of the Stability and Growth Pact — the pact that singularly failed in its sole aim of ensuring euro-zone members keeping their fiscal deficits and gross debt below 3 percent and 60 percent of GDP, respectively. Although there is general agreement upon the need for strengthened fiscal governance, it is far from clear whether EU states will be able to agree on what this should entail.

In an interview in late May with the Financial Times, EU Council President Herman Van Rompuy talked of his plans for stricter governance which, he hoped, would involve an assessment of “the main assumptions underlying the budgetary plans, like the levels of growth or inflation … total revenues, total spending and deficit targets.”

He added that “sanctions could already kick in before the 3 percent threshold for the annual deficit is trespassed.”

However, we have argued that such interference might be politically unpalatable — and not only for smaller states that may feel they are more likely to suffer such intrusion, but for bigger states.

Perhaps this explains why Germany, the Netherlands, and the United Kingdom, among others, have insisted that the “peer review would exclude the possibility that a government might be forced to rewrite its budget at the instructions of its partners.”

If such peer reviews lack regulatory “teeth” and realistic application, then it is unclear how the Stability and Growth Pact’s “corrected edition” can effectively discourage political inertia on deficit spending in an economic downturn — and succeed where its predecessor failed.

Clearly, Germany recognizes this and will push for "the imposition of interest-bearing deposits on governments that fail to observe budgetary discipline in good economic times, and suspension of EU aid funds for countries that repeatedly ignore recommendations to put their houses in order.”

Germany is also expected to push for expulsion of fiscally “recidivist” states, but it is hard to imagine smaller euro-zone states endorsing such recommendations and presumably treaty changes, so we must assume that they would enjoy the full backing of the ECB in this matter, given the bank’s opposition to ”expulsion throughout the recent crisis.”

As things stand today, in my opinion, it will be very difficult to come to a meaningful agreement at the EU summit this week.

Throughout the crisis, evidence of pan-euro-zone disagreement and procrastination on matters integral to the stability of Economic and Monetary Union have been a severe blow to the euro.

As such, despite reduced pessimism across markets, there are risks that further evidence of discord on Friday might bring the markets back to reality.

As Theodora Zemek, head of global fixed income at AXA Investment Managers said: “We are in a very major crisis that has even broader implications than the credit crisis two years ago. The politicians, and I would like to add ‘the markets,’ have not yet twigged to this … a ‘probable’ default by Greece setting off a chain reaction across Southern Europe … It would be the end of the euro as we know it. The long-term implications are at best a split in the euro zone, at worst the destruction of the euro. It is not going to end happily however you slice it.”

Finally, the dollar and euro three-month LIBOR both rose, with the dollar rate at its highest since July 6, 2009, and the euro rate at its highest since Dec. 29, 2009. The euro overnight LIBOR rate rose 32.13 basis points, due to the end of the European Central Bank maintenance period, while the three-month LIBOR rate was up 0.19 points.

LIBOR is telling us that we could be in for some stormy weather during the next few days.

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Now that it s clear to most investors that what's going on in Europe and with the euro is what s moving global markets, let s take a technical look at the euro itself. Having closed back above $1.2130, there is the possibility that the euro might now find its way...
Tuesday, 15 June 2010 05:49 PM
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