Eurozone crisis: In search of conclusive resolution!

“The momentum for a stable rebound in the economy has not yet been established”

-         Wen Jiabao

This comment from the Chinese Premier caused China markets to underperform the rest of the region overnight but with a Japanese bank holiday damping liquidity, and activity, it has been a fairly slow start to the week. The leading article in this week’s Economist argues that the US economy is reinventing itself and that the composition of growth is moving away from the debt fuelled expansions of recent years towards exploiting growing consumer markets across the emerging world. The US growth story may be the highlight of the developed world at the current turbulent economic juncture, however, Premier Wen could easily be speaking of almost any global economy (including the US) in his synopsis that we are not quite there yet!

UK’s Funding for Lending programme - positive for GBP
The announcement on Friday of the UK’s Funding for Lending programme, whilst probably not adding anything new from the Mansion House announcement should be seen as a positive for the UK and for GBP. While the uncertainty and negativity of sentiment towards the Eurozone have dragged GBP into the debate, going forward I am still very much of the opinion that GBP and the UK will outperform the EUR and the Eurozone (among others). In the short term, however, there is a chance that the Funding for Lending programme along with further QE continues to drive long-end rates lower and the resultant yields prove less positive for GBP. In addition to this it seems that over the last week speculative short positioning in the EUR has risen while the EUR has traded fairly sideways. This increases the risk of a correction.

Inflation and retail sales data eyed
On the data front there will be a refocus on inflation across the UK, US and Eurozone and while none of the major central banks have shown a concern for inflation, well behaved and (slowly) falling prices will be greeted with a sigh of relief from policy makers, particularly in light of recent expansions of monetary easing. Retail sales in the US and UK will also be a focus this week and will be watched as a gauge of consumer sentiment at this stage of the ‘recovery’, along with broader economic sentiment in the Eurozone with the ZEW survey tomorrow.

“Euro area hasn’t conclusively resolved crisis” – Angela Merkel

Today Germany’s constitutional court has said that it will not rule on challenges to the Eurozone's bailout fund, the European Stability Mechanism (ESM) until September 12, which is two months after its intended starting date. A further demonstration of the ineffectual nature of a monetary union without political union where the constituent parts are governed merely for the duration of their elected terms it is the wont of the people that will ultimately shape the ‘more Europe’ in Europe.

Spanish bank bailout MoU - ultimate liability where?
The focal point of the week, however, will likely be the release of the details of the Spanish Memorandum of Understanding (MoU), or conditions of the Spanish Bank bailout. The details are very important with specific reference to the ultimate liability of the Sovereign. In Greece, the finances of the state weighed destructively on the finances of the country’s banks. In Spain the opposite was true, particularly from the Spanish regions, but it is increasingly important to separate the two and remove the circularity or ‘negative feedback loop’ (as ECB president Draghi refers to them), between banks and the state. In this instance if the State is ultimately responsible for the debt, then it may result in a spike higher in Spanish Sovereign yields, which in turn drags down the creditworthiness of the banks themselves and in many respects defeats the objective of the bailout. However, the suggestion that the banks are directly liable to the ESM, hints at mutual liability and direct bank recapitalisations, both of which have received ideological and constitutional challenges from Germany.

A slow start to this week may eventually evolve into the higher volatility that I hinted at on Thursday and while I still continue to favour a lower EUR over the medium term, the risk of a correction or short squeeze in the short term is increasing and just for now I prefer to have a lighter position, looking to add after the squeeze and not cut back in it!