The Eurozone Has Become a Total Joke
October 26th, 2011
Play in the Euro currency at your own risk
– Markets have a binary focus on Europe but concerns are rising elsewhere. Data and central bank rhetoric
illustrate that fears over growth supersede inflation. We thought the comments from the RBI were incredibly
– AUD/USD is at risk ahead of tonight’s Q3 CPI and Q3 RBA Trimmed Mean(20:30 – 2.7% exp vs. 2.5% prior) . The
RBA meeting minutes and comments from RBA’s Battellino suggest the RBA may cut rates if inflation
decelerates. We see downside risks to inflation given the downward revision to Q2 inflation data and the cooler
global growth in Q3. We see downside in this cross but prefer to fade a rally following the EU leaders’ meeting.
There is resistance at 1.0500.
– We like to sell EUR/USD following the EU leaders’ meeting. We maintain that short of the ECB acting as a lender of
last resort, the announcement is likely to disappoint. Resistance at 1.4013 (Fib retracement from Aug high to Oct
– We still expect USD/JPY to range but fear of intervention is elevated and concerns that markets may suffer a
massive risk off wave tomorrow has kept Japanese policy makers on edge. The BOJ is likely to keep their bullets
ready in case the Europe announcement triggers chaos. Finance Minister Azumi indicated that decisive measures
are possible and we believe that more easing is likely at this week’s meeting.
Macro view and Wednesday’s U.S. session: Yet again, all eyes are focused on Europe. The market is expecting three key
elements: bank recapitalization, a haircut on Greek debt and a leveraging of the EFSF. At the close of the weekend, the only item
that appeared to have a consensus was the agreement on bank recapitalization. Though the IMF originally targeted €200B,
regulators have signaled that €108B will be targeted to achieve the 9% core tier one capital ratio. The mid-2012 target is
disconcerting as banks would have to speed up asset sales and are likely to limit lending. A number that exceeds this level may
not be well received. The questions of debt restructuring and the EFSF present the greatest threat to the market. A 60% haircut is
being discussed. Policy makers are walking on thin ice. The IIF seems to have backed down slightly from its original hard-line
stance on reopening the July 21 deal. However, they stress that there are limits to what can be considered voluntary investor
participation and moreover believe that a non voluntary deal would have severe contagion effects. Keep in mind, that according to
the IMF’s Global Stability Review, Greek CDS make up a mere 3% of the total market. However, Spain, Italy and France comprise
23.5% of the total market. We believe the PSI will be closer to 60% than 40% as the IMF indicated in the 4th review of Greece that
such a haircut may be necessary to put Greek government debt on a sustainable path. The key issue as far as we are concerned
will be the EFSF. Protecting the balance of the periphery is paramount. We still maintain that granting the EFSF a bank license
would be the most successful strategy. However, this plan is DOA. Plans to leverage through a first loss guarantee program is on
the table as is a potential SPV that European leaders may ask the IMF to run. The latter has some credibility to it and may help
extend the risk rally. Regardless of the plan, Germany’s approval process will complicate the issues as the Bundestag’s budget
committee has to be briefed before Merkel can negotiate. On the backburner will be the outlined plans on growth, fiscal
consolidation and fiscal coordination. Integration will take treaty reform and time. There may be some discussion on sanctions
regarding missing targets and leaders are likely to turn the heat up on Italy who at writing has not hashed out further austerity
measures. Regarding growth, it is evident by the data that most of the periphery Europe is already in recession and the PMIs
argue that the core is not far behind. We maintain that structural changes are needed (or devalued currencies) are needed to get
the economy back on track.
In the US session, outside of staying focused on Europe, we will watch durable goods (08:30 -1% exp vs. -.1% prior). The
capital goods orders nondefense ex air is forecast to rise +.5%. Increased business investment is key for US economic growth.
US Sep New Home Sales (10:00 300K exp vs. 395K prior) will be noted but not market moving. Following yesterday’s dovish
Bank of Canada meeting, the Monetary Policy Report will be of note. The Canadian backdrop seems strong compared to its global
counterparts and therefore the market will sift the reports for clues on the catalyst for the dovish tone. Regarding Europe, EU 27-
leaders are expected to start meeting at noon EST while EU-17 leaders are to begin their meeting at 13:15.
What could move the markets ahead of the US open?
There is not an exceptional amount to watch ahead of the US open. We highlighted the Australian QQ3 CPI above and note also
that the UK CBI Business Optimism will be released (06:00). Finally, the ECB will announce the allotment of its first 12-month
refinance tender. The amount of the liquidity in the system is minimal compared to the values seen in 2010. A high subscription to
the 12 month tender will be bearish for the euro on both supply and signs of bank stress.
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