WISE MONEY

German Chancellor Angela Merkel told Davos-”We need a big rethink”.Germany’s Chancellor Angela Merkel has told the World Economic Forum that a “big rethink” is needed in the eurozone within the global economy.

“Structural reforms that lead to more jobs are essential,” she told delegates at the Swiss resort of Davos. “Do we dare to be more European?”

The eurozone is still struggling with a sovereign debt crisis and is trying to agree reform to its political system.

But many want Germany and other nations to boost the size of their rescue fund.

The International Monetary Fund (IMF) wants the eurozone to inject more cash into its rescue fund.

The IMF wants the sum available for bailouts to grow beyond 500bn euros (£416 billion) to ensure talks between private creditors and Greece do not grind to a halt.

The situation is urgent according to the IMF, which recently predicted that the economic growth rate in Europe could halve this year from an earlier estimate of 3.3% if the eurozone crisis remains unsolved.
Lessons learnt

Mrs Merkel disagrees with Ms Lagarde about what is needed.

“We have said right from the start that we want to stand up for the euro, but what we don’t want is a situation where we are forced to promise something that we will not be able to fulfil,” she said.

Mrs Merkel said that the austerity reforms being enacted – currently being felt from the Irish Republic to Italy – had to be balanced with reforms of how Europe is governed.

Mrs Merkel also acknowledged “tensions” between countries that have adopted the euro and those that have not inside the European Union (EU).

Given that the main euro paymasters Germany- and the IMF disagree on how to solve the euro credit crunch- there is only one way this story is going to go.

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Money markets have fallen as eurozone finance ministers continue to force Greece’s private creditors to accept a lower interest rate on their loans to Athens.
UK and French share indexes closed lower on Tuesday, while Wall Street fell on opening.

Euro ministers said creditors must take less than the 4% they had offered and urged both sides to reach a deal this week.

A deal is necessary for Greece to receive the bailout funds it needs. Without the funds, Athens will not be able to make billions of euros of loan repayments due on March 20th.

The FTSE 100 index in London closed down 0.5%, while the Cac 40 in Paris fell 0.3%, but the Dax in Frankfurt reversed earlier losses to close slightly up by the end of trading, gaining 0.4%.

The Dow Jones Industrial Average in New York was down 0.3% in morning trading.

Ministers confirmed that 130 billion euros (£108 billion) was available for the country, but also called on Greece to accelerate structural reforms to strengthen its economy before funds would be released.

However, Charles Dallara, head of the Institute of International Finance (IIF), which is representing Greece’s private creditors in negotiations with Athens, warned Europe was putting a “decade of progress at risk” over the management of the talks.

He added the 4% figure was a firm statement of their intent. He said: “Our offer is on the table and our position is clear.”

He added Europe must keep the support of the private sector, given the massive amounts of debt that have to be refinanced from France to Portugal.

He added that there was not a country that did not need investment from the private sector.

“Investors need to feel confident in their investments in sovereign debt,” he said.  “There are a lot of issues that remain unresolved, and I’m not entirely sure the path to resolve them is truly framed”

The finance ministers, headed by Luxembourg’s Prime Minister Jean-Claude Juncker, said they welcomed progress made in the talks between Athens and its private creditors, but called for an agreement “in the next few days”.

Mr Juncker also made clear that ministers backed Greece over the rate of interest it should pay on new bonds that will replace existing bonds held by creditors.

Ministers reiterated that a deal with private creditors was essential for the European Commission, European Central Bank and International Monetary Fund to release further bailout funds.

The euro enjoyed its first strong day of 2012 yesterday with signs that some confidence could be returning to the single currency. One of the main topics of discussion at the moment is the ongoing Greek debt deal.

Negotiations had taken a turn for the worse over the weekend after the authorities asked investors to accept new bonds yielding 3.5% rather than the previously agreed 4%.

The Greek government had hoped to complete talks by Monday, but as yet, no agreement has been made.

However, Greek finance minster Evangelos Venizelos said progress was being made and this was one of the main reasons for the euro strength.

He has now set a new date of 1st February to conclude talks.

Although these comments have improved the confidence level of a deal being agreed, until any deal is signed, expect the euro to remain weak as the threat of a default is still alive.

The Bank of Japan kept their interest rates fixed at 0.1% as the bank noted that the Japanese recovery is moving slower than expected.

The strong Yen remains a problem for the economy with corporate revenues likely to be down as a consequence.

The ongoing debt problems in the eurozone remain the biggest risk to the Japanese economy.

Sterling has remained in the middle against its major rivals as the euro strengthened against both the Dollar and the Pound dragging Cable higher with it.

The main news out this week for the UK is the release of 4th Quarter GDP with a -0.1% figure expected.

This significant change in momentum has been priced into the value of the Pound though it will be a massive blow to the global recovery and could be the first of many negative GDP figures from around the World as a second recession starts to bite.

Against all the odds the single European currency has been resilient this week moving up towards the year to date highs of 1.3068, clawing back its losses and more.

The euro’s ability to defend bad news in Europe has been remarkable and its gains have reflected a speculative market that has been extremely short.

As we are light on headline data today the markets will have to observe the outcome of the somewhat positive Spanish and French debt auctions while keeping one eye on Greek debt talks with private investors.

But for yet another failure of talks in Greece the EUR should continue on a positive footing.

How long this will last is uncertain, particularly given the dangers ahead but at a time when investors have become progressively more bearish on the euro it may just extend its bounce over the short term.

One country to watch is Portugal whose bonds have underperformed recently as markets speculate that it could be the next contender for any debt note.

Back to the UK and Retail sales have come been announced close to median forecasts of +0.6% m/m and +2.6y/y.

Sales have improved in December but the improvement is likely to be short-lived, suggesting any support to the Pound will be brief.

Sterling has underperformed even against the firmer EUR of late but this is supporting better levels for the market to take long positions versus EUR.

This explains the move in relative European/US interest rate differentials, which has been linked with the move in EUR/GBP.

Overall Sterling could outperform EUR over coming months to around 0.80, with the former continuing to benefit from the simple fact that it is not in the Eurozone and has therefore acquired a quasi safe haven status.

Rising bank shares have lifted European stock markets amid hopeful economic signals, results from US banks and a report suggesting the ECB was providing more loans to banks than had been thought.Successful French and Spanish bond auctions and falling US unemployment claims also helped improve sentiment.

Bank of America and Morgan Stanley’s results were better than expected.

Commerzbank shares rose 15% after it said it would be able to increase its capital without government help. Also in Frankfurt, Deutsche Bank rose 8%.

In London, Barclays shares rose 10% while Lloyds and RBS were both up 9%.

In Paris, Societe Generale rose 13%, Credit Agricole rose 9% and BNP Paribas gained 8%.

The soaring bank shares helped Europe’s benchmark indexes to strong closes, with the FTSE 100 ending up 0.7% at 5,741 points, its highest closing level since the start of August.

The Cac 40 in Paris closed up 2% while the Dax in Frankfurt gained 1%.

Some of the gains in banking shares were sparked by a report from Morgan Stanley, which said that the European Central Bank was flooding the eurozone banking system with even more cheap loans than had previously been thought.

The recent rally in the euro was very surprising given the lack of any positive or even specific euro related news over the past couple of days. Market sentiment about the single currency remains low (after a temporary blip last week) because a Greek default is looming ever larger and European policy makers are still arguing over the rules that they hope will make the eurozone less weak moving forward.

In fact short positions (betting that the euro will fall in value) hit record highs over the past couple of weeks, which suggests there recent rally is more about shorts covering their positions, leading to the price of the euro rising forcing other shorts to cover, commonly known as a short squeeze.

If, as is likely, this explains the recent uptick in the euro and so we can expect more euro selling to resume once the squeeze runs out of steam.

Data for the eurozone for the rest of the week is extremely light, with the ECB monthly report showing how much the ECB is lending to stricken banks is due Thursday along with French and Spanish bond auctions.

Both auctions will be closely watched in light of the S&P downgrades on Friday.

Sterling has been fairly steady in the early part of the week.

UK Retail sales are the only release of note for the rest of the week but worth noting because they report over key Christmas period for the retailers and will probably give a good idea to the market if the UK economy is heading for (or is already in) another recession.

The US bank holiday on Monday has meant the US Dollar has also been fairly quiet so far this week, but Thursday and Friday sees a large amount of US data including the CPI figure, which should hopefully give the market an end of week shot of much needed direction in an otherwise rudderless few days.

After markets closed last night, Standard and Poor’s (S&P)  the credit rating agency dealt a severe blow to the European bailout fund by downgrading its AAA status to AA+. The agency blamed the large number of guarantors that had lost their triple A crown and therefore the funds itself could not maintain the gold standard rating.

Following the announcement, EU officials attempted to reassure markets that the funds will not change is ambitions to lend billions of Euros to struggling Eurozone states.

Proving how out of touch euro technocrats are the EFSF chief Klaus Regling claimed “The downgrade to AA+ by only one credit agency will not reduce EFSF’s lending capacity of €440 billion”.

This latest downgrade will increase pressure on Eurozone officials and German government to boost their contribution to the European Stability Mechanism which only becomes active in July.

Interestingly the euro has rallied so far following the announcement and currently sits at 1.2021 against Sterling and up against the Greenback at 1.2790.

This morning in the UK we had the latest CPI reading which indicated a 4.2% year on year according to the Office for National Statistics.

This is further fall following last months 4.8% figure and eases inflationary pressure on the Bank of England as it creeps lower towards the 2% target level.

This is the biggest year on year decline since April 2009, which was attributed to discounts on petrol gas and clothing according to the ONS.

The US re-opens today following its Bank Holiday for Martin Luther King day yesterday.

They start their week with Empire manufacturing data which assesses business conditions and expectations of manufacturing executives specifically in New York.

This is followed by a Canadian Interest rate decision where we are expecting them to maintain interest rates at 1.0%.

A new shockwave filtered through the markets on Friday as the credit agency Standard & Poors (S&P)- downgraded France, stripping them of its prized AAA rating. The decision to remove this vital asset in keeping borrowing costs to a minimum left France with a AA+ rating, a judgment that will likely cost billions in higher repayment costs.

S&P said “Europe’s austerity and budget discipline alone were not sufficient to fight the debt crisis and may become self defeating”.

Alongside France, S&P cut the rating of Italy, Spain, Cyprus, Portugal, Austria, Slovakia, Slovenia and Malta though it was expected that these countries would have their ratings lowered.

Overall, the picture isn’t looking good for Europe and with further downgrades likely over the next few months, it will be important to see how the ECB reacts in keeping this ongoing debt crisis under control.

The main winner from this continues to be the US Dollar with further gains against most currencies likely as investors pile more money into the global reserve currency.

For as long as the Greenback keeps this status, it will remain the market leader in these testing times as Europe sits on a knife edge between growth and recession.

There is very little data out today with the only comment of note coming from a speech by ECB President Mario Draghi due at 6pm UK Time.

It is likely he will focus on the downgrade on France and how the ECB will look to repair the damage it has caused.

The wise money markets continue to be driven almost exclusively by extreme changes in sentiment on a day to day basis. The recent euro rally stems from the positive outcome of Spanish and Italian bond auctions yesterday.

Both countries we able to place the bonds at considerably lower rates than in recent auctions lifting sentiment and the euro throughout yesterday and into this mornings trading.

Worryingly data just out showed Spanish Banks borrowing almost €140bn from the ECB in December, almost the record high set back in July 2011 and this tugged sentiment back in the negative direction.

Both central bank decisions were tame affairs, neither the ECB nor BOE changed rates or announced any change to existing QE programs.

For the Bank of England it seems to be a very much wait and see approach before they announce further asset purchases.

Mario Draghi and the ECB can be pleased with the results so far from the LTRO in December.

Confidence seems to be improving in the European banking system because investors now feel the ECB stands behind the banks, and this is translating into lower yields for European Government debt.

The positive US data flow of recent weeks came to a halt yesterday afternoon, with retails sales figures lower than estimates.

This afternoon’s confidence survey will be very interesting to watch to gauge the state of the consumer given such weak retail sale figures and increasing jobless claims this week.

Looking towards next week there is a huge amount of Chinese data to digest first thing Monday.

Positive Chinese data is generally seen as bullish for the world economy, and hence US negative, so the release will probably set the tone for sentiment for the early part on the week.

Europe will remain under the spot light over the next couple of days with the European Central Bank (ECB) meeting today, alongside debt auctions in Spain and Italy. The speculative market is predominantly short EUR while policy makers, specifically German Chancellor Merkel and French President Sarkozy are making the right noises; it appears the penny has dropped for Eurozone officials that it is not only about austerity but also about growth and reform.

Reports that Fitch ratings are unlikely to downgrade France’s ratings this year has provided a welcome boost to Eurozone confidence.

However Greece could yet spoil the party given the continuing dialogue with the Troika to decide the second bailout package for the country.

Political resistance within Greece suggests that more austerity may not be easy to execute.

For the time being there are ongoing questions about the degree of write-downs that Greek debt will endure.

In spite of these issues it looks like investors are becoming more immune to events in the Eurozone. While we still have high bond yields for Italy and other euro sovereigns it seems that risk appetite has improved.

One feature that is providing support to sentiment is the positive news out of the US.

Even though the Q4 earnings season has not started particularly well, data releases look rather more positive.

Last week’s US December jobs report continued to filter through positives to the market and we have also seen a pick up in small business confidence and a rise in consumer credit.

These recent improvements in economic data snaps highlight the gradual recovery process underway in the US and the growing divergence with the eurozone economy.

This supports the view of the US Dollar out performing the euro in the short to medium term.