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Euro Withstands Global Economic Jolts, for Now

Tuesday, 01 March 2011 08:16 AM Current | Bio | Archive

EU Economic and Monetary Affairs Commissioner Olli Rehn said today he expects oil prices to average around $100 a barrel this year.

He also stated he didn’t think there would be a double-dip recession in Europe because a 10 percent rise in the price of oil from an average of $80 per barrel in 2010 to $102, which is based on what he calls the normal methodology, this year would only have a dampening effect on growth of about 0.1 percentage points.

So, Europeans shouldn’t worry about $8 per gallon gasoline.
I’m not so sure about that, but as always we’ll have to wait and see and hope EU Commissioner Rehn is right and doesn’t try to sell wishful thinking.

The UK newspaper The Telegraph reports that David Cameron and other Western leaders are on the brink of ordering military action against Col. Moammar Gadhafi amid fears that the Libyan dictator could use chemical weapons against his own people. Remember that British sources have disclosed that Libya still has stocks of mustard gas and chemicals.

The Pentagon has also stated: “We’re repositioning forces to provide for flexibility once decisions are made (about Libya).” The Pentagon is believed to be considering moving the USS Enterprise from the Red Sea into the Mediterranean to take up a position off Libya.

While dark clouds continue gathering around the Mediterranean Sea, in China, the official PMI falls to 52.2 in February, which is a six-month low, from 52.9 in January but nevertheless better than the forecast of 52.0. The privately calculated HSBC’s China Purchasing Managers’ Index falls to a seven-month low of 51.7 from 54.5 in January.

Also, Secretary General of the China Development Research Foundation, Lu Mai, tells the WSJ that the yuan (CNY) “still has room to appreciate.” However, he interestingly notes: “But the U.S. shouldn't worry about 8 percent "undervaluation.”

And Liu Mingkang, head of the China Banking Regulatory Commission, warns: “Over the past two years, to confront the financial crisis loan growth has been abnormally explosive. It has exceeded the extreme upper managed limits.” He also notes: “The scale of new loans has increased incredibly fast, even doubling, in just a short period, but the expertise and efficiency of loan officers can’t have doubled at the same time.”

Now, among all that growing uncertainty what really strikes me is that sentiment towards the euro has remained remarkably firm over the past month.

Despite the tumultuous events, for Europeans just across the Mediterranean Sea and a squeeze on oil supplies, most noticeably for Italy, the euro has seen, so far at least, continuing inflows and is trading at its highest levels against the dollar since early November 2010, which was by the way, just before the Irish crisis started. Of course, there are expectations that the ECB could raise interest rates this week.

Considering all this, it could seem that to some investors the euro has regained, for now at least, a good part of its former “safe haven” status.

Closer attention, however, reveals a rather less optimistic reality. As has been so often the case over the past 14 months, the signals we get from the fixed income and credit default swap markets appear to indicate that not everything goes that well in the Eurozone.

Yes, January has been characterized by rising levels of optimism and that the worst of Eurozone crisis was over, but this month in February we have noticed a notable reversal. From February 4 onward the price of 5-year credit default swaps on peripheral Eurozone debt has been moving steadily higher. Indeed, as of yesterday’s close the cost of insuring against a Greek, Portuguese or Irish default stood not that far short of the record levels that were in place at the start of this year.

Similarly, from that date onwards the yield gaps between peripheral sovereign debt against their equivalent German 10-year Bund have widened to such an extent that they are now trading at levels that are also not far short of where they stood during any of the major troughs in sentiment of the past year or so.

Indeed, it is noticeable that the Portuguese (actual yield 7.55 percent) / German (actual yield 3.19 percent) 10-year sovereign bond spread, that’s now at 436 basis points (bp), continues to threaten a run at the all time closing high of 479 bp where it stood in mid-November of 2010.

Meanwhile, we also should take notice that we continue to see steady outflows from Portuguese and Italian debt while German paper continues to enjoy its status as the number one European bond safe-haven. Also today, the 10-year Greek sovereign yield is flirting again with the 12 percent (in euros) yield as it stands at 11.99 percent.

So, why has that reversal of sentiment taken place? Well, during the first week of February there was a lot of talk about joint Franco-German proposals for “enhanced economic convergence” in the Eurozone.

However, practically all the other Eurozone members were not delighted at all with the French/German “Invitation” for closer coordination of tax, wage and pension policies when they met at the summit of European leaders on February 4.

German Chancellor Angela Merkel and French President Nicolas Sarkozy reportedly unveiled their proposal during that daylong meeting and called on fellow Eurozone members to hold a special summit in March “to agree” on their new proposed measures, which would install in fact new binding agreements that would cut across existing EU initiatives. And yes, that didn’t land very well. Indeed, one EU diplomat told Reuters: “The discussion became really quite heated … One EU leader asked Sarkozy and Merkel if they really thought it was right to treat everyone else in this way. He was insulted.”

In the face of this fierce opposition Paris and Berlin decided then that discretion was the better part of valor and chose “not to put a paper on the table.” Since then efforts has been made to craft a newly revamped “pact for competitiveness” ahead of the March 11 Eurozone summit.

Whether the new proposal will manage to bring down the frayed official nerves remains to be seen. Interestingly, for now it’s the evidence from the fixed income and CDS (Credit Default Swaps) markets that indicates it’s the investor’s nerves that need to be calmed.

In my opinion and after those series of “false euro recoveries” over the course of the past 12 months, investors may be getting tired of continuously giving the Eurozone the benefit of the doubt.

If true then, I can’t imagine other than the euro not ultimately reacting negatively as well, similar as to what we have seen in November 2010.

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EU Economic and Monetary Affairs Commissioner Olli Rehn said today he expects oil prices to average around $100 a barrel this year. He also stated he didn t think there would be a double-dip recession in Europe because a 10 percent rise in the price of oil from an average...
Tuesday, 01 March 2011 08:16 AM
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