“As the poet said, ‘Only God can make a tree’ — probably because it’s so hard to figure out how to get the bark on.”
Commentary & Analysis
The Ebb and Flow of Hope in the Eurozone
Each time I think the eurozone is backed into a corner, it manages to find a new corner through the magic of political persuasion and a market belief in financial engineering. Or a simpler summary may suffice: Leaders in the eurozone continue to pull rabbits out of their hat. But even rabbits can reproduce only so fast!
It seems, yet again, we are approaching something that may resemble the endgame, he says with a sheep like degree of confidence. I am thinking about two scenarios:
- Germany does not allow the ECB to become the buyer of government debt of last resort and the euro experiment ends. Good for liberty. Near-term bad for markets.
- Germany allows the ECB to become the buyer of government debt of last resort. Good for euro and risk assets near term. Long-term it likely doesn’t matter.
I think number one above is clear: the European Financial Stability Facility (EFSF) has already proven a failure. So to pretend that will save the day even though Italy and Greece have “changed” governments seems quite wishful thinking.
Number two makes it more interesting. If the ECB commits, we will likely many bank analysts across Europe emerge from the woodwork saying “I told you so; the euro is here to stay.” This group, throughout this game, has been too close to the problem and has too many vested interests (and pressures) to see it for what it is, in my opinion. But, no matter; any announcement could lead to at least as sharp rally in the euro and would likely mean a big move in all risk assets.
But the justifiable rationales for the ECB becoming like the Fed, in a massive QE program, are the reasons why the game will likely end badly next year, instead of this one.
Germany will mandate draconian austerity measures and close to absolute control if it agrees to allow that latest ex-Goldman Sachs hire–ECB chief Mario Drahi–morph the ECB into the Fed.
The ECB will indeed be flooding the market with euro as it buys sovereign bonds non-stop, but Germany will be monitoring budgets and debt levels. Therefore, we would have a situation of austerity on one track and monetary policy on another. Who wins? Austerity I think.
We need only consider how ineffective (arguable by many who believe with lots of merit that things would have been much worse) the Fed’s massive build in its balance sheet and QE programs have been for the US real economy. And it was accompanied by massive fiscal stimulus from the US government and there is no intermarket imbalances going on the US as there is in Europe. It is why I think austerity trumps the ECB in the end.
So, beyond George Soros and the rest of the collectivist pols and their pals who would be giddy seeing their Davos World Order back on track, all of the same structural problems remain in the eurozone.
I ask the jury of market opinion to consider these nicely loaded questions:
Didn’t Greece, Ireland, Italy, Portugal, Spain and the rest borrow money at ridiculously low rates for about seven years during the experiment to build the new reserve currency and centralize all thought–economic or otherwise–in Brussels?
How is it that effectively doing the same thing, but this time have the ECB do the buying instead of the banks and those in the market who actually believed the spreads would never blow out in the weak countries relative to Germany going to solve the problems of intra-market competition?
- Are the new governments of Greece and Italy going to be so good that they can convince citizens a decade or more of austerity of pain will payoff for them so they can become competitive with Germany? The last group of pols seemed to have some problems there and explains why they are now looking for new jobs–likely somewhere in Brussels or elite US universities economics and poly-science departments.
- Is there any other path available if ECB bond buying fails? Nope, they are in their final corner here, I think.
- Will the Eurozone countries finally agree “we are all Germans now” and get it over with? Unlikely. Especially when you consider there is a whole bund of “truth” in this little joke about How Germany sees Europe that is making the rounds below:
Interesting the euro is not following through on the good news from last week. Buy the rumor sell the news? It is still surprising and may be very telling. Why?
Maybe we are getting back to fundamentals! I mean, if you compare the potential depth of a Eurozone recession and massive amount of euro supply that could be thrown on the market (by the ECB),the euro has the worst of the two intermediate-term fundamental drives for a currency in play:
- Falling yield differential (ECB cut in the midst of this)
- Falling relative growth (foreign direct investment fleeing for other pastures)
A falling euro now would not be a bad thing for the Eurozone that badly needs wealth creation. But, until we get evidence to the contrary, we have to believe this game is still pure risk on and risk off; with the Eurozone itself the key driver of this environment. Let’s call it the “ebb and flow of hope.”
Conclusion (summary of all the guesses above in other words): The market sees all that I just talked about and the euro has seen its high for many years or potentially forever. Or there will again be a better place to sell the euro e.g. when George Soros reaches maximum optimism that the powers that be have again won the day.
As the best we can do is watch, wait, and play the setups we think give us that slight edge. As intellectually appealing as it may be trying to forecast the euro outcome, it can be equally as dangerous to a trading account.
For now, the primary trend is down. And from a probabilistic perspective–the trend is our friend; as trite as that sounds.