Macro Analysis: Insight into Europe, Asia and FX

Telegraph Article Points to Fire that Der Spiegel Smoked

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While many in the market saw bluster in yesterday’s Der Spiegel article, I smelled smoke. The article written by Ambrose Evans-Pritchard in the Telegraph,

shows there is indeed fire behind the smoke.

AEP asserts that Jorg Asmussen, Germany’s member of the ECB’s executive council, fully backs ECB President Draghi. AEP also confirmed that ‘ECB technicians are examining plans to cap Spanish and Italian bond yields,’ with the analysis on how this can be done lead by Ulrich Bindseil, the ECB’s Director-General of Market Operations.

The ECB’s meeting in September will be the time and place when this plan is presented to the ECB members. Up to this meeting the ECB will draft the model for action.

The market consistently calls for action from the ECB. Unlike the US FED, the ECB is treading through unfamiliar ground. It takes time to draft consensus and agreement, it also takes time to make sure that any action falls within the bounds of the ECB’s mandate.

AEP points out that, “Mr. Asmussen told the Frankfurter Rundschau that the surge in Club Med bond yields over recent months “reflects fear about the reversibility of the euro, ad thus a currency exchange risk” rather than bad economic policies in struggling states.” He points out that the wording is important. “If it can be shown that the ECB is acting to avert EMU break-up – known as “convertibility risk” – bond purchases would no longer be deemed a bail-out for Italy and Spain.”

Now there are some that have been saying any move by the ECB to cap yield differentials between Spain/Italy and Germany would be terrible news for Germany as it would push up German borrowing costs. These detractors fail to understand the liquidity differentials between the ‘Club-Med’ countries fixed income markets and Germany’s. It doesn’t take much to move Spain and Italy yields lower. It would take much more to push German yields higher.

French economist Guy Sorman had an excellent piece in the weekend’s Wall Street Journal, “Guy Sorman: Why Europe Will Rise Again”

I think this piece is excellent reading as it goes into depth on how much EUR detractors underestimate the political will European leaders have for the EUR to stay together.

I fully believe the ECB will give the green light to yield manipulation. It is not a new concept, after all, the US Federal Reserve keeps US yields low in the face of fiscal difficulties, as do many countries that have embarked on quantitative easing. It has become so prevalent that many commentators in the US use the low US yields as a reason for US fiscal health. A case in point would be John Cassidy’s piece in the New Yorker, where he states: “(If people in the markets truly believed Ferguson’s analysis, the U.S. government would never be able to issue ten-year bonds with a yield of well under two per cent).”

Mr. Cassidy fails to mention yields are where they are because the US Fed is buying that paper.

As  of writing, the EUR/USD is trading at 1.2420. Should the ECB follow along the lines of that suggested by Der Spiegel and the Telegraph, which I think it will, then there could be a significant squeeze higher in the EUR/USD, especially considering the technical breakout of the downtrend witnessed last night. I continue to be a EUR/USD bull. I do not see myself as a contrarian, but rather as someone who is convinced of strong EU political support, and ECB action.

Douglas C. Borthwick
Macro Analyst

Written by MacroTack

August 21, 2012 at 8:31 am

Posted in EUR/USD

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