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Eurozone Starts Off New Year on Shaky Ground

By    |   Friday, 07 January 2011 02:36 PM EST

What’s upsetting in the eurozone this time?

In December, I was struck by the euro’s limited reaction to wholly unsupportive news flows. I started looking for serious signs whether the euro’s relative strength reflected the growing presumption (which in my opinion would be more an exercise of wishful thinking) that a political solution for the eurozone would ultimately be found.

Now, this week’s 3 percent losses of the euro to the dollar would appear to suggest otherwise. It looks like December was rather more about squaring-up than anything else and, in fact, that fits nicely into these end-of-the-year window-dressing exercises that some many big-money players are obliged to do every year.

No, not all news out of the eurozone has been reassuring during this first week of 2011.

Interestingly, this point was highlighted where we see Eurostat, which is the statistical office of the European Union, revising down for Q3 the quarter over quarter GDP growth rate of the eurozone to 0.3 percent from 0.4 percent in its first estimate and down from 1.0 percent growth in Q2 of 2010, while we saw in the U.S. GDP increasing by 0.6 percent in Q3 of 2010 (after 0.4 percent growth in the previous quarter), and by 1.1 percent in Japan (after 0.7 percent growth).

We also saw the seasonally adjusted unemployment rate remaining stubbornly unchanged in the eurozone at 10.1 percent in November 2010, which is still up from 9.9 percent in November 2009 — and which is, frankly speaking, “bad news.”

By the way, the lowest unemployment rates were recorded in the Netherlands (4.4 percent), Luxembourg (4.8 percent) and Austria (5.1 percent), and the highest in Spain (20.6 percent), Lithuania (18.3 percent in Q3 of 2010) and Latvia (18.2 percent Q3 of 2010).

Also, earlier this week the news wasn’t that good when relating to the December services PMI. Markit chief economist Chris Williamson said that “near-record growth in Germany and strong expansion in France contrasted with a collapse in growth in Italy to near-stagnation and increased rates of decline in both Spain and Ireland.”

Yes, the eurozone continues to grow apart.

Negative data also came out of Germany with the November retail sales report constituting the worst of the bunch, while French consumer confidence also slumped.

Perhaps Yves Mersch’s stated view that “now the time is near for policymakers to withdraw economic stimulus at a moderate but steady pace” was certainly unlucky in timing, notwithstanding I must admit that we saw Eurostat estimating the eurozone annual inflation rate at 2.2 percent in December 2010, which is two notches above the 2 percent Maastricht treaty/ECB mandated target rate. No, the eurozone doesn’t start the New Year under its “lucky stars” scenario.

But as always, eternal optimists will point to the fact that China and Spain have just signed US$7.40 billion (5.72 billion euros) worth of agreements, 24 hours after Vice Premier Li Keqiang said “China is a long-term and responsible investor in the Spanish bond market, and China has not reduced, but even increased, its investments of Spanish bonds.”

However, I wouldn’t become that quickly optimistic because such reassurances, which the Chinese also extended to Greece some months ago, haven’t prevented periphery yields from rising.

This may be down in part to suspicions that aside from China and the ECB, the breadth of buyers in the market is “unhealthily” small, and this would certainly help to explain the limited relief derived from this week’s ostensibly positive EU government debt auctions.

Accordingly, despite some respite in early December, bond spreads have drifted relentlessly higher and jumped sharply this week, which in the case of Greece, resulted in a near eurozone lifetime high of 12.77 percent (in euros, of course!) in its 10-year yield and spread of 9.86 over German bunds, or the 10-year German benchmark Treasurys that yield 2.91 percent at the moment of this writing.

With liquidity yet to return to optimal conditions, the picture could yet change significantly as the month unfolds and as real money investors formulate their strategies for 2011.

However, it is clear that the eurozone remains in troubled waters, and we may suspect renewed selling in EUR/USD if the key uncertainty, which would stem from the market’s realization that its renewed confidence in the U.S. economic recovery had been ill-founded. The significance of today’s U.S. jobs report therefore cannot be understated.

For long-term investors and as stated here so many times before, dollar-up means most of the rest down. Yes, dollar-up could easily lead to a turndown in nearly all markets. Therefore and before all, I would take a complete risk-aversion attitude for the time being, which is of course pro-dollar, and do so by putting “my profits in my pocket!”

Although there are certainly some significant releases on next week’s schedule, investors will have to wait until the end of the week before they get the next installment of U.S. figures.

As such, today’s U.S. non-farm payrolls report may well set the tone for the week, given that positive U.S. economic data now appear to be feeding dollar’s strength rather than fuelling the dollar’s substitution for higher yielding currencies, a positive print may go some way to ensuring a further week of positive dollar performance.

Tension remain fraught across the eurozone’s debt markets, with spreads rising further this week,  weakness in the periphery economies and successful debt auctions.

Also returning was a familiar turn of phrase employed by the region’s politicians, with the best quote in my opinion coming from the French Prime Minister Francois Fillon, who stressed on Thursday that the turbulence in eurozone sovereign debt markets “didn’t signal a crisis for the euro.”

You can believe what you want, but I certainly don’t believe him.

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What s upsetting in the eurozone this time? In December, I was struck by the euro s limited reaction to wholly unsupportive news flows. I started looking for serious signs whether the euro s relative strength reflected the growing presumption (which in my opinion would be...
Friday, 07 January 2011 02:36 PM
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