Positions in Europe: Short EUR/USD (FXE); Long German Bonds (BUNL)
Keith added FXE to our Real-Time Positions at $129.13. FXE’s TRADE range is $127 – 129 with a TAIL resistance of $131.
With regard to the trade Keith said: “Europe didn't cut rates today. But they will, again, eventually. This is the Currency War. Immediate-term TRADE overbought within a bearish long-term TAIL.”
We’ve written a number of notes on Europe this week. Certainly at any moment the EUR/USD can be influenced by numerous factors, however below are the larger forces we think are acting on the cross:
There is great political uncertainty in Europe right now, which lends support that the EUR/USD will not cross our quantitative long term TAIL line of resistance at $1.31. The market consternation centers around:
- If and when Spain will seek a sovereign bailout
- The extent to which the ESM can directly recapitalize troubled banks, and
- The terms around setting up a fiscal and banking union
On a banking union we’ve already seen push back from stronger nations like Germany to “blindly” accept this risk (ie without conditions to benefit itself and/or limit reduction in its credit rating) and coordination to set up the logistics of a fiscal union inducing a protracted drag in this decision.
To the point on timing, ECB Executive Board member Joerg Asmussen said on Monday that the ECB will not rush through “half-baked” plans for a new pan-European supervisor.
Also, remember that German Chancellor Merkel and Bundesbank President Jens Weidmann continue to butt heads on many fiscal issues. Eurobonds is one topic that Weidmann remains vehemently against while Merkel has not ruled out their use. However, if the Eurozone is to move to a fiscal union, Eurobonds are simply a natural extension of a fiscally united union. This is one hot topic to monitor as we move through the calendar year.
NO CHINESE SAVIOR
Interestingly, this week, Jin Liqun, chairman of the supervisory board of the China Investment Corporation (China’s $480B sovereign wealth fund), said that CIC will not buy bonds issued by debt-ridden Eurozone countries until their fundamental problems are solved. This point is of note because some over the last 12 months have suggested there’s a reduction in “risk” across Europe given the willingness of the Chinese to step in and support the region. Further, Jin said:
“The mass demonstrations in Greece and in Spain against fiscal tightening do not bode well for attracting investment into their debt… It's not realistic to expect any Chinese investor, CIC included, to buy the bonds, which are not safe…If the euro zone would issue a Eurobond backed by all of the countries - it is more attractive to international investors. Backed by all of the countries means backed by the core members."
European Manufacturing and Services PMIs for September (released on Monday and Wednesday, respectively) have shown little to no improvement over the last 7-8 straight months, stuck below the 50 line indicating contraction (see chart below).
The next immediate political catalyst for the cross is the Eurogroup being held next week in Luxembourg on October 8-9, however we do not expect any definitive action to be agreed upon. Taken together, we are fully aware of the powers of Central Bankers to drive the EUR/USD. That said, the fundamental data from Europe keeps us grounded in our opinion that despite best efforts from Eurocrats to craft rescue programs, we think slowing growth, rising inflation, and the structural flaws inherent in creating a Eurozone will continue to present challenges that should prevent appreciation of the EUR/USD above our TAIL line of resistance at $1.31.