Devil is in the detail?


One didn’t have to wait too long for a small dose of rationality after last week’s landmark euro-summit sweet-talked a two per cent uptick in the single currency, sparking risk appetite and bidding up commodity currencies. Yet the next day’s headlines sobered traders posturing towards strategic longs as Italy’s debt problems resurfaced, vindicating my take that the tea leaves clearly signal a medium-term short on the euro. Even oil pared earlier gains going into the weekend as European confusion combined with a decline in Japanese industrial output to renew fears of weakening international growth.
The euro may still have some topside elbow room left, but hardly any intrinsic strength beyond strong resistance at 1.4250. Last week’s suggestion to leverage the brief post-summit rally for a strategic short still holds as scrutiny into the euro’s biggest one-day rise in a year reveals loopholes in the bailout mechanism. The ESFS expansion, the 50 per cent bondholder haircut, bank capitalisation requirements, though impressive as an exhibition of continental solidarity, hardly amount to a fundamental departure from what 13 other summits achieved in 21 months. Greece is in default, Italy’s borrowing costs are rising and nobody has the slightest idea how banks will raise $120 billion in present market conditions, except handing out stakes to BRIC and emerging market sovereign wealth funds at heavily discounted prices. Even if possible, how it will help Europe, its banks, or the euro is still not clear.
Despite a serious aversion to conspiracy theories, I cannot ignore rumours of Germany printing deutsche marks when they come from Dr Pippa Malmgren, an enigmatic former White House and Deutsche Bank economist whose deep understanding of financial markets fascinated me some years ago in Dubai, as my first baby steps in the complicated world of financial markets coincided with the crash of ’08. This, combined with the German constitutional court ordering a halt on a parliamentary panel’s efforts to green-light bailout disbursement, strengthens my conviction that the euro might not survive in its present form. For now, look for the trend reversal to short with abandon. If meeting after executive-level meeting cannot prevent another great slide, the market will have already priced in the death rattle of the euro, ending an enchanting era of the euro area’s romance with the free market.
Even as euro remains the central figure, yen uncertainty is still on the rise despite the BoJ’s best efforts to discourage safe haven inflows. But with the yen at 75.78, finance minister Jun Azume has no more rabbits to pull out of the hat, and intervention must come soon. Currency appreciation has seriously hurt exporters, and Tokyo will not be able to hold off big companies from breaking down its door for long. Nintendo, for example, expects to record its first loss in 30 years, a bad omen for an economy struggling with years of recession.
Strangely, bets are still open for interest rate decisions from both Europe and America. Analysts are pretty much split on a possible QE3 as Bernanke & Co juggle improved quarterly growth and a stagnant job market. Most European commentators expecting Mario Draghi to cut, on the other hand, fail to notice that Trichet was not the ECB’s chief hawk, but Bundesbank executives still paranoid from the hyper-inflation hangover of the Weimer Republic’s collapse. Interestingly, Europe’s existential uncertainty is proving beneficial for sterling-longs as Wednesday’s euphoria subsides and risk makes its way out of the market again. But discretion should be the better part of valour for serious traders, as volatility abounds and the risk pendulum swings at the euro’s cue. In the immediate term, dollar, yen, sterling, oil and commodity currencies will all move with the eurozone’s heartbeat, especially if the union goes into cardiac arrest. The devil, as always, is in the detail.