Home > Uncategorized > 2011/04/01: Market Implications of ‘Non-Starter’ European Financial Stability Facility (EFSF) Grand Bargain

2011/04/01: Market Implications of ‘Non-Starter’ European Financial Stability Facility (EFSF) Grand Bargain

Just to begin the blogging adjunct to our primary analysis with a bang, how about the degree to which all of the European Monetary Union rescue plans seem to be a lot of hot air? We’ll get back to how that relates to our recent main analytic views below. But for now, the degree to which those rescue plans are inconsistent within themselves and significantly self-defeating is striking.

We have expressed our own incremental shift in views from the impressive ‘early agreement’ on a ‘deal’ two weeks ago, into cynical realism last week when EMU officials said they couldn’t possibly tackle the expanded funding and functions for EFSF until this summer. But the crux of the matter is that even what has been ostensibly agreed is significantly less than credible.

Thanks to Wolfgang Munchau for another of his incisive Financial Times Commentary columns, as this one explains the major inconsistencies within the current EFSF ‘Grand Bargain’. (And as we have suggested on many occasions, anyone who has not already set up a profile on www.FT.com should do so posthaste.) Access our highlighted version of that analysis at http://bit.ly/hFtlRV, with the original column on FT.com available at http://on.ft.com/eTksLi.  

It boils down to a blatant example of the continued defense of their narrow self-interest by the successful members of European Monetary Union; and the degree to which the assistance to the members who are under pressure is neither sufficient nor rationally structured. We will soon be posting more on how the self-interested position of the Germans in particular is going to prevent any rational outcome for the peripheral European Debt-Dilemma. In the meantime is it any wonder that this week’s headlines continued to trumpet the degree to which the financial pressure on the periphery of Europe is accelerating instead of receding in the wake of the Grand Bargain?


How all of that relates to our recent TrendView Updates is straightforward on one hand, and a bit more of a subtle, if major, insight on another. As we have noted for many months, the German Bund is the most challenged of the primary government bond markets. While Germany’s solid fiscal position has caused it to rally initially during European Debt-Dilemma crisis phases, as everyone is increasingly aware of who will foot the bill for any ultimate bailout that leaves the euro intact, it comes under pressure. And the realization that Germany is increasingly likely to face a capital call from EMU, Inc. has left the Bund quite a bit weaker than its developed economy peers.

As such, it now finds itself far more distended to the downside against long-term trend averages than either the US T-note or the UK Gilt. Based on today’s market Closes, it is more than six points below its 41-week moving average, as compared to only four points for the other two; that’s quite a difference, yet it seems to be rightfully so.

And amidst all of that European Debt-Dilemma disarray, there is even a more major inference to be taken from the foreign exchange markets than the obvious good reasons government bonds are under pressure. How bad must the US dollar really be that it is losing ground against the euro? In the wake of that announcement by EMU finance ministers that they were not going to address insufficiencies of EFSF until this summer there have been a multitude of scary indications from the periphery of the Euro-zone.

While there has been a steady stream of those stories for weeks, a simple look at today’s financial news highlights that tensions are growing over Euro-zone peripherals. Those include Portuguese government borrowing rates hitting new highs (exacerbating its unsustainable fiscal position), announcement of major additional funding needs for undercapitalized Irish banks, failure of the merger of one of the weaker Spanish banks creating an urgent situation there, and all of that in the context of sustained inflation that will soon cause the ECB to raise its base rate (possibly as early as next Thursday); which will of course be more bad news for the weak sisters in Europe.

In fact, we will soon share further analysis of why all of that will be exacerbated by a seemingly intractable situation. And one of the drivers for that worsening of conditions in Europe (the much-feared ‘additional external shock’) is indeed the likely further weakness of the US dollar. That intrinsically brings along with it another burden for the European economy; stay tuned for that one.

Yet the primary question remains how, even as the euro gave up ground against the really strong currencies this week, the US dollar continues to weaken against the euro? All of the reasons and psychologies behind that are part of cross currents so diverse as to defy a simple, logical deduction. Suffice to say that it speaks for itself: for it to weaken against the euro over the past several weeks in the wake of the sort of headlines that have come out of the European financial arena, the US dollar must be a really crappy currency. Undoubtedly the reasons for that will make themselves much more glaringly apparent in the not too distant future.

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