‘Like giving vodka to a drunk’

Europeans protesting the vodka-for-drunk like club med bailout seem to have finally struck a chord with the union’s supreme lending authority as Chancellor Merkel cites need to prepare for a default the market increasingly seems factoring in as inevitable. That the French would vehemently disagree was guaranteed since their banks’ heavy peripheral exposure combines with the country’s debt and deficit troubles to force the Elysee Palace to play second fiddle in the debt drama. The past week, though not without incident, did little to clear the confusion surrounding Europe, still the currency markets’ central player, its peaks and troughs deciding fortunes of currencies and economies near and far.
Trichet’s bowing out announcement, that the ECB will resume covered-bond purchases and reintroduce year-long loans for banks, lifted the euro above 1.3400 on Thursday. But Friday morning’s credit downgrade of Spain and Italy quickly reversed the trend, with the common currency erasing the week’s gains before settling at 1.3375. September’s inflation uptick no doubt played a part in keeping rates steady even as Trichet warned of the crisis freezing money markets. And, at the risk of repetition, failing significant steps, the euro will test last week’s 1.3000 forecast sooner rather than later, especially if there is truth in rumors that the cut was held back due to political concerns, to let Draghi start his term with a bang.
Cable (GBP/USD), on the other hand, surprised to the upside on Friday despite Moody’s downgrade of 12 British financial institutions. The previous day, sterling tumbled against the dollar after the bank of England kept its main rate at 0.5 per cent and announced increasing the bond-purchase program by 75 billion pounds. The uptrend was helped by encouraging data from America as risk appetite staged a brief comeback. But in the absence of intrinsic improvement, the pound just does not have the juice for a prolonged rally. Going long cable is not advisable in the current environment. Shorting EUR/GBP is far more prudent, since euro area problems are far from over, and market chatter speaks of the Bundesbank printing marks again. If true, the euro has already been delivered the kiss of death in circles that decide the continent’s monetary fate.
Also, despite the brief risk-buoyed emerging market rally, their continued slowdown clearly disproves the decoupling myth in the present market environment, proving such detachment cannot hold when the developed world is in such bad shape for so long. As the European crisis chokes liquidity and threatens to drive down global growth, options traders have turned bearish on the Brazilian real and South African rand. The real, Hungary’s forint, Poland’s zloty and other developing-country currencies dipped more than 12 per cent on average, according to Bloomberg. In stark contrast to expectations of interest rate increases not long ago, Brazil and Turkey have cut borrowing costs to help growth and push up exports, clear short signals for their currencies. With Chile and Mexico increasingly posturing the same way, further slowdown will be the go-ahead to sell emerging market currencies.
Market gyrations continue to fend off long term positions, with inter-day trends dictating trading patterns. Such uncertainty will last at least till the European narrative assumes a definitive outlook. Best to go long emerging and commodity currencies while brief risk on windows last. This phase will end as soon as European leaders quit doling out more vodka for the drunk periphery.