Derek Halpenny at Bank of Tokyo-Mitsubishi UFJ published a note early on Monday whose title made his opinion plain enough: Massive policy shift will only temporarily lift EUR. Halpenny highlighted the about-turn by the ECB as early as Thursday about a bond purchase programme and the panic (my word) reinstatement of fixed-rate tenders and dollar liquidity swap lines to conclude: “These are clearly astonishing shifts from both eurozone officials and from the ECB that appear a clear attempt to shock the financial markets back into normal functioning. But we recently became more bearish on the EUR, not in the belief that the eurozone would implode but in the belief that a mix of tightening fiscal policy in the region would be coupled with looser than anticipated monetary policy by the ECB. We stick with that view and indeed the shift from the ECB this weekend will have the market pondering the idea that the stance of the ECB will be far more accommodative than expected and for far longer, leaving the euro locked in its current downtrend.”
Bank of New York Mellon’s commentary by Neil Mellor was also somewhat less than taken with “a ‘shock and awe’ display”. Mellor questioned the likelihood of the proposals being ratified in Germany, especially now that Merkel’s coalition no longer has a majority in the Bundesrat. He also pointed out the implications of Gresham’s law for the ECB’s mooted sterilisation of government debt purchases: “…there is a risk that the ECB obligingly mops up quality debt resulting, increasingly, in the sale of higher quality assets and a markedly deteriorating balance sheet.” Mellor then highlighted the Fiscal stability pact “mark II” that the EU was to begin to discuss on Wednesday, “discussions that will surely conclude with closer monitoring and inspection of regional finances and statistics through the course of the economic cycle. Aside from the questionable politics behind smaller states being ‘inspected’ by their larger brethren, the new improved pact’s Achilles heel will nonetheless remain the same: governments resisting expansionary, deficit financing once its economic fortunes begin to falter.”
BNP Paribas followed with an FX special note – Losing EUR trust. BNP summed up: “The current EUR rally should not be confused with a long-term trend change… EUR short covering will not be followed by EUR investments despite intra-EMU spreads coming down… Germany has only reluctantly approved the fiscal package. The media have been reporting that the German government is checking the constitutional risks of the EMU rescue package… EMU fiscal consolidation will be the next big topic. The German tax reform seems to be buried while inherent deflationary risks remain significant, suggesting EUR weakness.”
The last section of the note is headed EUR will enter free fall and recaps BNP’s analysis that a forthcoming EUR sell-off will be down to an erosion of trust. The reduction of credit risk on the back of the programme “means that risks are not eliminated but substituted by other risks.” One of the risks being that of diminished EU and ECB credibility and a consequent liquidation of currency reserves held in EUR. BNP ended by saying that with the EU “converting the currency union from a stability union into a transfer community and the ECB easing monetary conditions on what looks like a response to political pressures, the EUR will be super-soft.”
It is possible that, regardless of the erosion of the credibility of the European authorities, the measures will buy a little time to demonstrate (or not) the willingness by Portugal, Spain, Italy and others to manage severe fiscal consolidation. Analysis in Credit Suisse’s FX monthly, released Tuesday, leaned towards this view, saying: “On the one hand, tail risk has been reduced significantly; at the same time the ECB’s exit from policy accommodation has been pushed back. We think EUR/USD is likely to remain supported in the immediate aftermath… and would expect further tests above 1.30 in the days ahead.” Credit Suisse did see “a period drift back lower through our 1.29 three-month forecast target”, which was just as well, and on a 12-month basis the bank saw scope for recovery to 1.36.
Any deviation from fiscal rectitude, or any escalation of social unrest in response to it, will once again weigh on the EUR. But this still ignores the measures that Germany needs to take. As Charles Grant, director of the Centre for European Reform, said to Reuters: “Germany isn’t understanding that it is part of the problem. It has to stimulate demand to reduce its current account surplus, but that is going to lead to more political tension and discussion over who needs to do what to correct the economic imbalances.”
Whether Grant said that before the release of German trade figures for March is not known, but the biggest monthly increase in German exports in nearly 18 years only reinforces his point.
Finally, I admit that my own initial impression of the EU’s measures was that of an enormous Madoff-style con, an impression was not lessened by the concluding sentence of Neil Mellor’s piece: “As awesome a ‘shock and awe’ display as [the] announcement from the EU was, the true cost and just how it plans to pay the bill remains to be seen.”
This was echoed by a quote, late Monday, from Charles Diebel, head of European rates strategy at Nomura, picked up by Reuters: “The headlines are all very impressive but the question marks are: ‘Is it executable?’ and ‘How is it funded?’”
And this, from an anonymous contributor to the website Zero Hedge, didn’t help at all: “Does nobody, including educated financial journalists, ever question where all this bailout money is coming from – when all the donor countries are in debt themselves [and] also soon in need of a bailout?”
I question it all right. And the only answer can be from future economic growth – despite negative demographics (just when do those baby-boomers retire?) and in the face of ultra-competitive emerging market economies.
