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Positions in Europe: Long Germany (EWG); Sold the British Pound (FXB) yesterday

Today German Chancellor Angela Merkel expressed her support for Mario Draghi as the next president of the ECB – pushing Draghi from frontrunner to near foregone conclusion to take over from Jean-Claude Trichet in October.

We’ve spent time this year discussing the seat change of the ECB Presidency. After our initial favor for former Bundesbank President Axel Weber was dashed when he withdrew his candidacy in early February, Draghi rose to the rung of “best of the rest” in our book.  Today’s backing by Merkel completes the four biggest Eurozone countries (France, Italy, and Spain) to endorse Draghi.  A formal push of endorsement from the union may come as soon as May 16th when the Eurozone finance ministers meet in Brussels. In any case, the region will push to name Trichet’s successor many months before October to ease the impact of the transition.

While Draghi brings impressive international credentials, including as Executive Director of the World Bank, chairman on the Financial Stability Board, and as current Governor of the Bank of Italy, we continue to have our reservations. As we’ve highlighted before, his hang-ups include:

  • From a PR perspective (whether you want to believe it or not) Draghi as an Italian citizen is symbolic of southern Europe’s governmental fiscal irresponsibility. Italy has the 4th highest public debt across the globe, at 118% of GDP (behind Japan, Greece, and Iceland) as persistent sovereign debt contagion threats, primarily from the periphery, continue to dampen growth prospects and incite volatility in the EUR.
  • Draghi has the backing of Italian Prime Minister Silvio Berlusconi – his praise and approval is tainted by concurrent trials addressing his numerous political and sexual scandals.  
  • Draghi worked a 3-year stint as a vice chairman of Goldman Sachs in which his duties included arranging currency swaps that helped Greece hide the extent of its budget deficit.  This reflects poorly against a European populous that blames investment bankers for the region’s credit crisis and resists country bailouts.

Monitoring the market implications of sovereign debt contagion in Europe, uneven fundamentals across the region and movements in the EUR versus major currency remains a daily process. On the long side we continue to like Germany (via the etf EWG), and expect underperformance from the region’s peripheral countries.

We’re seeing significant weakness in the EUR-USD intraday (blowing through our immediate term TRADE line of support of $1.44) as tens of thousands protest austerity measures in Greece and S&P said Portuguese banks might possibly require more significant government support. Stay tuned.

Matthew Hedrick