Positions in Europe: Short Italy (EWI)
It appears more likely that the ECB may keep interest rates on hold when it meets tomorrow (and likely choose to cut later into year-end) given the preliminary September CPI report that jumped 50bps to 3.0% year-over-year. Equally, we expect the BOE to be on hold, a position it has maintained since March 2009 despite pressing inflation—and here we’ll reiterate that policy makers are in a box with the country stuck squarely in stagflation with little room to cut interest rates to spur growth (see chart below). We’d fade any commentary from Cameron & Co. that the economy is running in a positive direction. And today’s Final Q2 GDP report in which Q/Q was revised down 10bps to 0.1% won’t help sentiment!
Tomorrow marks an important meeting for the ECB as it is President Trichet’s last meeting before Mario Draghi takes over on November 1. As we’ve written about in the last months, the ECB is in the unfavorable position of being the one institution that may need to significantly contribute to Europe’s sovereign debt and banking “bazooka” bailout, while the Bank’s mandate and position (at least until now) remains to shy away from all things related to fiscal policy [short of the SMP] and focus solely on its mandate of price stability. If the last months have proven anything, it’s that there are flaws in this system, or at least to the extent that one monetary policy can govern uneven economies, especially in a slow to negative growth environment. Yet don't discount the resolve of policy makers to continue to attach fiscal "band-aids" to the Union's imbalances.
In any case, we’d expect to see the ECB cut its main rate of 1.50% sometime into year end, but wouldn’t be surprised if it didn’t come tomorrow. The high frequency data we follow continues to trend lower as inflation remains above the Bank’s 2% target, but within a range that should come in over the coming months. Reflecting slower growth, today we received PMI Services data across the major economies. The SEPT data shows a marked slowdown month-over-month, with the Eurozone, Germany, Italy and Spain all below the 50 line, which signals contraction.
Germany, in particular, continues to remain THE country carrying the biggest stick when it comes to voicing the direction of Europe’s sovereign debt and banking contagion crisis, which may continue to take pressure off the ECB to not only act on monetary policy, but fiscal policy as well. However, it’s equally clear that neither Chancellor Merkel nor Brussels have any clear idea about how to get out of this mess. Yesterday the market in the US rallied on a late-session article from the FT that said EU officials are examining ways of coordinating recapitalizations of banks and agreed that additional measures are urgently needed. This news is also clearly boosting European equities today, yet again we’d warn that that such “news” will provide at best a short term rally.
Below we’ll leave you with some recent quotes from Chancellor Merkel as it relates to the sovereign debt and banking crisis in Europe. What stands out is that Merkel sounds increasingly of the opinion that performing wall sits to save the Union over the longer duration benefits both Germany and the Union.
Merkel reaffirms anti-Eurobonds stance: issuance of shared debt by euro countries isn’t the solution to the problem spilling from Greece, even though some may long for the “big bang” to end the debt crisis… “Whoever believes that has no clue about the economy.”
Merkel on Default: A Greek default would have unpredictable consequences, lead to speculative attacks on other highly indebted euro countries and risk sending German economic growth into reverse. Letting Greece default would trigger “a gigantic loss of confidence” in euro-area sovereign bonds…”
“No one can say with certainty” what would happen if Greece defaults…. Before I make a nifty step into an adventure, I have to ask whether we can really handle this and can we oversee what we are doing?”
“Solidarity is always cheaper than if we were to go it alone and wind up with the problem Switzerland has -- that the currency level is so high that you can’t export any products anymore. Today, going it alone is no path to a better future.”
Going into tomorrow’s meeting we see a bearish immediate term TRADE range in the EUR-USD of $1.31-1.34. The pair remains broken on an intermediate term TREND duration.