25 October 2011 at 8:59 GMT
“The government solution to a problem is usually as bad as the problem.”
– Milton Friedman.
The positive tone for risk assets continued in yesterday’s trading session, despite the disappointing deterioration of the manufacturing and services sector surveys from the Eurozone, once more questioning the future growth trajectory of the Eurozone once its troubles have been finally given a backstop. The revelation from the German opposition leader yesterday afternoon, following a briefing from Chancellor Merkel, that the bailout fund would be leveraged to at least EUR1 trillion through a combination of the ‘insurance model’ and investment from outside organisations such as the International Monetary Fund, boosted equities (lead by banking stocks – though Greek bank stocks were hit very hard on the growing reality of a 60 percent haircut on their Sovereign’s debt) and broader risk assets, including to a certain degree the EUR.
End of EUR relief rally?
However, as I alluded to in yesterdays blog, I feel that we are coming to the end of the ‘relief rally’ for the EUR and further gains (beyond the technically important 1.4060 level in EURUSD) will be much harder work for the currency of the troubled Eurozone. In fact the risk reward is starting to turn in the other direction from here. The political resolve of the Eurozone has demonstrated it is likely to deliver what is needed (at least to avert the short-term disaster – or tail risk that I alluded to yesterday) but is unlikely to produce a plan that goes beyond expectations.
Whilst the predominant focus of financial markets remains the Eurozone debt situation, the better than expected outturn in Chinese Manufacturing PMI (HSBC measure) and an improvement in the Japanese trade deficit (driven by improving exports) added to the positive global macro economic backdrop.
Australian CPI and U.S. GDP in focus
Also outside of the politicking and negotiations of the Eurozone, Swiss banks will likely settle a sweeping probe of offshore tax evasion by paying billions of USD and handing over the names of Americans with secret bank accounts as U.S. and Swiss official negotiations conclude over coming days. The move will likely add to pressure to reverse the recent decline of the USD, however, the more pressing focus will be on Thursday’s advance estimate of Q3 US GDP in that regard. Australian CPI will also be a focal point for markets (providing Wednesday’s eurogroup meeting can draw an immediate line under the speculation surrounding the concerns of the Eurozone), as investors make the transition back to the economic backdrop and relative value – markets are still pricing in around 100bps of cuts from the Reserve Bank of Australia over the course of the next year!
Key German parliamentary vote
On the day, headline watching will still be an important pastime. Further developments around the German lawmakers, who have secured a full parliamentary vote on Wednesday to debate any crisis measures negotiated by Chancellor Merkel, will be key. The Bundestag budgetary committee will ultimately have a veto on the plans to leverage the European Financial Stability Facility. While it is unlikely to block the proposals, there is a potential for a ‘market disappointing’ delay.