German Chancellor Angela Merkel told Davos-”We need a big rethink”.

“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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German ratification of an enlarged eurozone bail out fund was supposed to calm market nerves going into the weekend.

Today is the end of the third quarter and with financial institutions set to report earnings over the next couple of weeks there is usually increased volatility as last minute balance sheet window dressing taking place, so be prepared for greater than usually swings in parings today.

Markets remain sceptical that European politicians have the political will and ability to finally put this crisis to bed because of the fragmented nature of the political system between member countries.

This is why we are hearing strong words from across the Atlantic about the need to for further enlargement of the bail-out fund, its current size would not support both Spain and Italy and the Germans have explicitly capped its size at the current €440 bn.

The New Zealand Dollar, not often mentioned by Wise Money was the big mover in the currency markets overnight after Standard & Poor’s downgraded their credit rating one notch from AA+ to AA.

The Kiwi Dollar responded immediately, falling across the board and compounding its recent declines on the back of the deteriorating outlook for global growth.

Which- if you have gone to see the rugby world cup will make buying any more kiwi dollars more competitively priced.

All of the so called commodity currencies are closely correlated to the outlook for world growth and it is the recent revisions by the IMF and other agencies that are the main reason the strongly performing high yield currencys like the Kiwi and Aussie Dollar and the South African Rand has lost ground against Sterling and the Dollar.

Greece will once again be the key driver in the markets for the week ahead as inspectors assess whether the Greek economy is on schedule to meet its debt obligations due next month and so avoid a default.

Doubts are growing that Greece are still not doing enough to align with the financial assistance provided.

Politically the pressures are growing with Angela Merkel the German chancellor losing another regional election in Berlin, in addition nine out of ten Greeks are dissatisfied with the governments handling of the crisis.

Last week the euro regained some lost ground and Greek two year notes improved for the first time in two months, this followed rhetoric from Germany and France to keep Greece in the euro area.

However this week we once again hit a crunch point and we will see what the divergence is between political will and confidence in the financial markets- Asian currencies have fallen on renewed fear on Euro debt as we kick start the week.

Elsewhere, we have seen a small gain in UK house prices for September in a survey by Rightmove- the Pound has marginally improved against the US Dollar and the euro on the back of this data.

Economic data will also be very important this week following the IMF and OECD pointing to a lower global growth outlook. The highlights will be Bank Of England minutes and Public sector net borrowing from the UK.

The minutes will highlight the thought process of the MPC and the potential for more QE in the future.

We have several American data releases on the menu this week but possibly the most significant for the US Dollar exchange rate will be the minutes of last months FOMC meeting.

The Fed’s attitude at this point will be the major factor of whether the Dollar can maintain its rally over the next few weeks.

The lack of encouragement in US bond yields suggests that USD drive could slow, with markets likely to shift into wide ranges over coming weeks.

One should also consider which currencies will suffer more in the event of further USD gains.

The relationship linking the USD index and EUR/USD is extremely strong signifying that the USD gains are mainly a result of the single European currencies woes.

Apart from the EUR, GBP, AUD and CAD are the most susceptible major currencies to USD strength as many emerging market currencies including ZAR, TRY, SGD, THB, IDR, and MXN, are all highly susceptible to the impact of a stronger USD.

Japanese officials have been avoiding further forex interference blaming the drop in USD/JPY over recent weeks on general USD weakness in spite of the move towards 80.

However, this stance is not really backed up by correlation analysis which shows that there is only a very low sensitivity of USD/JPY to general USD moves over recent months.

One explanation for the strength of the JPY is strong flows of portfolio capital into Japan, with both bond and equity markets registering net inflows over the past four straight weeks.

After a brief rally this morning, The Pound is beginning to drop back again.

First thing this morning the Nationwide House Price Index showed British house prices falling 1.3% year-on-year and we can expect Sterling to remain under pressure with the release of construction PMI, mortgage approvals & net consumer credit due later.

Sterling looks set to take a back seat for the rest of the week as no change is expected at the MPC meeting on Thursday, a rate rise by the ECB is not completely off the table and the Non farm payrolls from America is due on Friday.

Portugal finally agreed the terms of its bail-out, easing its debt concerns, at least for the next few years, but given the success of the Greek (possible default or restructuring) and Irish (penal rate of interest currently being renegotiated) bail-outs I’m certain this will not be the end of the matter.

Caretaker Prime Minister Jose Socrates said he achieved a good deal – let’s see if he is still saying that in 6 months time, if he manages to cling to power.

Eurozone Sevices PMI also showed a drop compared to forecast, but nothing like the UK and so the Euro is relatively unaffected.

We did see commodities and equities ease as a result of a decision from a major futures exchange to increase the margin for trading silver prompting a wave of profit taking in both silver and gold.

This then filter through to forex trading and, coupled with a comment from ECB President Trichet who said that maintaining a strong Dollar was in the US interest, caused the Greenback to make a bit of a recovery.

Last Friday’s data from the US was on the slightly weaker side of ‘as expected’ with new home sales roughly in line but the Dallas Fed manufacturing index marginally softer.

With the escalation of tensions in the Middle East / North Africa region now encompassing Syria, the Euro has headed back to its last week’s highs, with the Dollar again recording fresh lows against the Swiss Franc as oil once again turns higher.

We are scheduled to get several risk events this week that will test the market’s resolve on its bearish stance for the Dollar.

The first of these is the FOMC rate announcement tomorrow afternoon but more important will be the press conference that follows.

Despite growing concern that 1st Qtr GDP in the US will emerge as softer than originally hoped, expectation is that Ben Bernanke will send a clear signal to the market that the current tranche of QE, scheduled to end in June, will finish as planned.

There is currently no reflection of tightening monetary conditions in the forex market so, dependent upon the tone of the Chairman’s comments tomorrow, there appears good potential for a stronger Dollar going forward.

Currency conflicts at the G20 gathering in Nanjing continue to undermine markets with the obvious divisions between member nations on the way forward causing the very moves that participants are looking to correct.

He adds that becoming a constituent of the IMF’s currency basket would be the clear evolution.

The European delegates remain wary of further Dollar strength with the French President, M. Sarkozy summing up the concern when he argued against the Euro, or any other currency, usurping the Greenback role as the global reserve medium.

He added that recent Euro strength versus the Dollar was unjustified.

Overnight, we saw the stronger Dollar from the last few days give up some of its gains on comments from Federal Reserve member Bullard clarifying his reported remarks from the day before.

He said that there is no consensus on the FOMC about ending QE2 early, and that this is unlikely to take place.

He also said that the Federal Reserve would be able to tighten policy by not necessarily pushing up official rates, but by starting to sell back assets adding that this cycle of tightening would be far more difficult to manage.

The weaker Dollar / stronger Euro scenario was further enhanced by yet more comments from ECB Board members, Bini-Smaghi and Stark who both cemented in the probability of a rise in the official Euro interest rate at next week’s regular meeting.

The former talked of rates being returned to normal levels in a “gradual way” whilst Stark pointed out the fact that policy rates at present levels were exceptionally low.

1) To begin with, it wasn’t all about a weak Euro; the Dollar itself has maintained its current bull run with the $ index rising from 79.13 at the start of the year to just above 81 this morning, which is itself a high since the end of November.

2) Expectation of the US economy continuing to recovery at a goodly pace, and the emergent treatment of the Dollar as a growth currency, has convinced traders that being long of the greenback is the way forward.

3) However the persistent negative news coming from the Eurozone, linked to a feeling that policy makers in Europe are a little short on ideas for getting out of the current mess, that is really keeping the Euro under pressure.

An EU proposal that European Banks’ senior bondholders should suffer losses on a failure before taxpayer are involved in any bail-out was ‘blamed’ for the initial push lower but news from Portugal of an offering of longer term bonds next week (after the 6-month bill sale on Wednesday) that accelerated the move.

This means that over the next fortnight Italy, Spain, Greece and now Portugal will all go to the markets to try and raise funds – it is no surprise that traders are nervous.

Political turmoil in Belgium is adding to the unease over the Eurozone’s future and having Hungary at the helm of the good ship Europe for the coming 6-months is not designed to add much confidence.

Analysts are looking for Euro/Dollar to push towards 1.2840 ahead of the US data but with the spot rate now sitting below its 200 day moving average (1.3080) further moves lower might need to be more hard-fought.

Today the focus will be on the US employment data later today but given recent amendments to the estimates of the report, since Wednesday’s ADP numbers, any volatility will likely occur prior to the release rather than post-publication. More important today will be the content of Bernanke’s testimony to congress.

The G20 meeting was the non event that everyone was predicting.

The hope was for a commitment to restrict current account surpluses/ deficits to a percentage of GDP but surplus countries (Germany, China Etc) dug their heels in and even refused to accept such loose dialogue.

Friday’s rumour that Ireland was about to go cap in hand to the EU gathered momentum over the weekend, Irish Prime Minister Bryan Cowen denied that a bail-out was needed, but further comments this morning by Irish officials has left the door open for EU assistance.

German comments suggesting the Irish should accept the bail out to avoid further contagion in debt markets (read Portugal and Spain) spooked the markets and undoubtedly made any market based resolution even less likely.

More poor data from Rightmove continues to show deterioration in the British Housing market, but this has not affected Sterling in the majors very much in light of the larger Eurozone story.

The Bank of England minutes are released on Wednesday (not to be confused with the Quarterly Inflation report last week) showing  MPC voting preferences from the last meeting,  we also have CPI and RPI inflation data out tomorrow which no doubt show inflation still running ahead of its target level of 2% plus or minus 1%.

Finally we have jobless claims, retail sales and public sector debt levels also out this week in a busy one for Sterling.

Dominique Strauss-Kahn the IMF’s Managing Director said co-operation between countries had weakened since the financial crisis started in 2008.

There is also the risk of bubbles in financial and property markets. And capital inflows can go into reverse – as they did in the Asian crisis in the 1990s.

So the third element in the currency “war” is the resistance of emerging economies, and some developed ones too.

Brazil and Thailand have used tax measures to slow the inflows. Japan, South Korea and others have intervened in the currency markets, buying foreign currency in an attempt to interrupt the rise of their own.

There is a view that they will just have to live with it. The upward pressure on the currencies of many emerging economies reflects the fact they are more growing strongly than the US.

It is difficult for them to manage, but the underlying reason is that they are doing relatively well.

The currency war is closely linked with another theme that has been troubling many economists for several years, that of global economic imbalances.

In international terms, it is trade that is unbalanced. Actually, the thing that is most often the focus is the “current account balance”, which means trade in goods and services plus some financial items, including remittances that migrant workers send home.

Usually, though, trade is responsible for most of the current account imbalance.

Some countries have large trade surpluses, notably China, Germany, Saudi Arabia and Russia. The biggest deficit country is the United States.

Some countries at the eye of the European storm have hefty deficits too – the PIGS aka Portugal, Ireland, Greece and Spain.

Britain also has a deficit, although as a share of national income, it is not all that large.

The other side of international imbalances is high savings at home with a surplus country such as China, and relatively low savings in a deficit country such as the US.

Household savings have risen in the US, the UK and other deficit countries, because consumers are borrowing less in the wake of the financial crisis.

But international imbalances also reflect how much governments borrow and in many deficit countries that has risen, partly offsetting the increase in private savings.

Why does all this matter? Those countries where saving has risen desperately want to export more. They want to sell more abroad to make up for consumers at home drawing cutting back their consumption.

That is true of the US, Britain and many others. They could do that more easily if consumers in China and the other surplus countries were willing to buy more imported goods.

A rise in China’s currency would not be a cure all, but it would probably help in the short term. Although it would also create greater inflation.