The Euro, Greece, Europe and the New ECB President

by Marc Chandler

Seeking Alpha
May 15, 2011

There have been a number of developments in Europe over the past several days and the euro has broken down. Its nine cent decline in nine days demands attention. The 5 and 20 day moving averages have generated bearish technical signals, led by sterling, followed by the euro, and confirmed by the Swiss franc.

Other bearish technical developments have taken place. The euro broke below its 50 day moving average for the first time since mid-January, came back to test it before the weekend and failed. The euro posted an outside down day on Friday the thirteenth as did the Swiss franc. Sterling staged its own reversal in the middle of last week when the market assumed the downward revision to the Bank of England's growth forecast and upward revision to inflation forecasts meant a rate hike would be forthcoming. The next key chart points are found in the $.139-$1.40 area for the euro and $1.60 for sterling.

Rate Differentials: I have been consistently explaining the moves in the euro as largely a function of the divergent trajectories of monetary policy, which is interrupted from time to time by a flare-up of European tensions. The price action of the euro, to me, is very important over the next couple of days. The rate differential widened during the second half of last week and the euro made new lows for the move. If the euro does not recover soon, it could very well be a warning sign that the risk premium for holding euros has risen and that this is not simply a position squaring adjustment. This is supported by the options markets insofar as the risk/reversals favor euro puts by essentially the most (~2%) since mid-Jan when the euro's rally began in earnest.

Greece: The recent unscheduled European meeting was important in that key officials acknowledged that Greece's situation was not resolved. Two-more years of financial support is about 60 bln euros, it is reckoned on the basis of maturing bonds, but more needs to be thrown in to cover budget deficits (and not as well) and increased costs for debt servicing. My sense after trying to make sense of the cacophony of official-speak is that on balance a new package, targets, and conditions are preferable to restructuring now or leaving the monetary union, for the euro-elite.

It seems that the talk of Greek exit was very much part of the acceptance that more money would be needed. Policy analysis is ultimately policy advocacy. By analyzing the potential courses of action, the costs of the less desirable paths are projected higher and that allows (forces?) the focus on less costly paths regardless of how unpleasant it is. I am not so much interested in the terms. The more debt that is piled on to Greece and the more assets is has to sell to foreign creditors (as perhaps some of the EU conditions may require) and/or transfer of its gold, the more likely the restructuring will be and the larger the haircut. The 800 pound gorilla in the room is German domestic politics and few if any are discussing it in the context of the debt crisis. It is not clear that Merkel can deliver the Bundestag to support more aid to Greece. The government enjoys a 20 seat majority, but the local press reports 19 defects, though the vote probably will not be held for several months, and that is with the opposition supporting Merkel’s aid request. Writing a small check now is preferable to a big one now. That a big check may have to be written in the future is a different issue and one that will not be addressed now.

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