Perhaps the euro’s most daunting fundamental hurdles in months has passed. And, as expected, the reaction was naturally bullish. The EU Summit this past week was a lightning rod for the market’s fears of a global financial crisis spreading uncontrollably with Greece and the Europe at the center of the storm. Naturally, some sense of ‘resolution’ to this imposing concern lightens the burden on the shared currency and global risk appetite trends. However, a big picture view of this situation tells us that the larger issues are far from resolved. More accurately, policy officials have bought themselves time. However, for investors and traders, time equates to an open window to place capital in depressed assets that are carrying yields that were leveraged during the depths of the crisis.
There is a critical difference between a relief rally and a true bull trend. Though we have just recently the market’s drive the fundamentally-troubled euro higher; we have already seen the signs that the market is making the distinction. In a sustainable ‘bull wave’ it is imperative to draw capital in at higher levels to maintain momentum. Yet, to encourage such aggressive investment, there must be a clear view whereby risk diminishes to boost the relative appeal of return or the potential for a European investment yield itself needs to rise dramatically (beyond the possibility of short-term capital gains on a depressed exchange rate). We simply do not have the case for a strong sustainable advance.
The rally has managed a rally against its benchmark counterpart (the US dollar) since the beginning of October. Notably, this is a move that coincides with the climb from the S&P 500. This suggests that a rebound in speculative interests / risk appetite has been the most influential driver to this point. The encouragement that the EU has stemmed the time of a financial crisis through its Summit really didn’t factor in until the EU and banks reached an agreement for a 50 percent writedown on private Greek bond holdings early Thursday morning. Taking a critical view of the three point approach that was agreed to; the writedown is the only factor that is immediately actionable – and even believable.
For an increasingly skeptical market (there have been many efforts at a rescue before this), the fact that the EFSF is expected to be leveraged by 4 times (to approximately 1 trillion euros) comes into question when we consider the lack of details and the inherent risk in using a bailout program. Furthermore, the bank recapitalization scheme sets an aggressive 9 percent core tier one capital ratio; but the 106 billion euro expected funding need smacks of an underestimate akin to past Stress Tests and forcing the banks to ask a skeptical market first is an unfavorable confidence vote that could stir fear once again. We may find more details next week to their process and approach when the G20 meets in Cannes, France Thursday and Friday; but we won’t likely receive serious details until the November 8th Summit.
We will fully be concentration this coming week on risk appetite trends for euro guidance. Should the October rally that has carried sentiment for the fundamentally-troubled and speculatively-depressed alike falter, the Euro’s heavy risk going forward could easily swamp the measured return potential for the currency and its assets. Potentially cutting the return factor even further, we have the ECB rate decision on Thursday. The economist and market consensus is for no change under new President Mario Draghi; but there is a small contingent calling for a cut. After the efforts made this past week on the fiscal front, it is not so far-fetched to see a cut. A reduction is not priced in; and that creates a serious ‘fat tail’ situation. An interesting question though: could a cut be seen as encouraging?
source from: dailyfx
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