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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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.

Festive cheer in the money market seem to be running out already as we move towards the end of the first trading week of 2012. Disappointing Italian and Spanish PMI data more than offset a decent German figure and the eurozone is looking more and more likely to be heading into another recession.

The euro was under pressure for most of yesterday as risk was dumped and the US Dollar strengthened.

The theme is continuing this morning as the single currency continues to be sold; European banks continue to make headlines for the wrong reasons as they park newly created ECB cash back at the central bank rather than lending or investing it in the real economy.

Retail gloom continues to hang over the UK with many of the retailers reporting crucial Christmas figures this week.

Next shares were pummelled after they reported disappointing sales over the festive period and set a gloomy tone as we wait for results from rivals M&S.

John Lewis were a ray of light in the gloom, posting impressive sales growth compared to last year, but most if not all retailers are suggesting that economic conditions remain a real concern and are expecting a challenging year.

The Pound has opened the year in much the same way as it finished the last, namely taking a back seat to the Euro and Dollar with economic fundamentals remain less of a driver than politics.

The wise money is hoping for a clear sign of the economic picture on Friday from the Non-farm payrolls, either showing the recovery continuing or a worsening picture and the prospect of further QE this year.

More likely is that the number shows the US economy to the chugging along slowly, leaving both the Fed and the markets disappointed.

European stock markets started the year in optimistic style with gains led by the German DAX index after the release of better than expected levels for eurozone purchasing managers indices (PMI). Furthermore, Chinese data indicated a rise in its PMI which helped to boost risk sentiment.

The combined eurozone data however, remained at a weak level, contracting for a fifth month in a row, and remains constant with eurozone recession.

One would not expect this equity rally to continue over the rest of this week, as risk aversion is set to play out alongside the on-going Eurozone debt and global growth worries.

Indeed, both French and German leaders in their new year messages talked about the risks ahead.

A summit between Germany’s Merkel and France’s Sarkozy is planned for January 9th ahead of an EU Finance Ministers summit on January 23rd. It is unlikely that there will be any major policy decisions in Europe before then.

In the meantime, German press reports suggest Germany is pushing for an even bigger write down of Greek debt than previously approved will only add to risk aversion over the short term.

The report in the Greek press highlighted the prospect of a 75% write down of Greek debt a far cry from the 20% proposed some months ago.

Eurozone markets continue to be troubled by the scenario of credit downgrades by major ratings agencies at a time when many countries have to issue hefty amounts of debt to suit their funding needs.

Against this background the EUR is set to remain under pressure, with a notable drop below EUR/JPY 100, its lowest level in over a decade registered. Reflecting the deterioration in sentiment for the currency, EUR speculative position hit an all-time low at the end of last year. This is unlikely to reverse quickly, with sentiment set to deteriorate further over coming weeks and months as the EUR slides further.

After the blow to the euro following the Standard and Poor’s ratings news on Eurozone countries, the currency has managed to regain some form of stability ahead of the EU Summit commencing tomorrow. Hopes that the Merkozy French -German deal which was publicised on Monday will be finalised at the summit are high and the threat by S&P means that the stakes are getting higher should there be a halt in progress this week.

Apart from placing the ratings of fifteen Eurozone countries on negative watch, S&P stated that the EFSF bailout fund may be downgraded too.

The single European currency however, looks to have found form in advance of the summit and the ECB meeting tomorrow, as news of talks to structure the bailout fund into two separate forms looks to strengthen the currency.

In other news the decrease in the Royal Bank of Australia’s new cash rate applied further pressure on the Aussie.

It’s fair to say the timing of the cut was not fully expected however the Aussie drop was restricted by the somewhat neutral RBA policy report.

The announcement did not support the idea of additional easing in the months ahead coupled with the much firmer than expected Q3 GDP this suggests that markets are too dovish on Australian interest rate expectations.

The Euro has continued to fall lower against Sterling in recent times whilst teh Pound looks to have settled into a range.

Sterling sentiment has clearly deteriorated over recent weeks as reflected as the market looks to becoming increasingly short.

The Pound has not been helped with a run of particularly poor data  and yesterday’s UK house price data was no exception, indicating a fall in November house prices alongside retail sales which dropped more than expected.

The ratings agency Standard & Poor’s left the growing mood of optimism about the eurozone debt crisis in ruins last night by warning the wise money markets that 15 of the regions 17 countries face credit downgrades if politicians do not gain control of their economies. S&P blasted Brussels “defensive” management of the crisis blaming the prolonged dispute among European policymakers for destroying investor confidence.

All of the AAA rated sovereigns which includes Germany and France have been placed on “negative credit watch”.

S&P highlighted that the French banks were a particular worry as the amount of external debt has risen above France’s GDP.

The timing could hardly have been worse as German Chancellor Angela Merkel and French President Nicolas Sarkozy sent investor sentiment soaring earlier.

Their united front had led to a significant drop in the borrowing costs for many of the struggling Eurozone nations including Italy, whose 10 year yields dropped below 6%.

The other announcements due out this week have been made rather insignificant though the central bank meetings due out on Thursday will maintain some weight in the markets.

The Bank of England will keep their base rate on hold at 0.5%, but any comments from the MPC Committee will be looked into.

The ECB will reveal their decision 45 minutes later and they are expected to cut their rate back to the 1% it was reduced to during the height of the credit crunch.

If this is the case, it will show a remarkable turnaround in the fortunes for the eurozone as the interest rates seemed to be on an upward curve in the 2nd quarter of this year.

We are set for an extremely busy and important week for the eurozone.The main event looks set to be the announcement of a deal on fiscal union between member states on Friday night, but what the market expects this deal to look like and what the deal actually looks like may well turn out to be two different things.

What the euro needs is further fiscal integration between members with the plan of a centralised treasury to eventually raise and distribute taxes.

What the French and Germans are likely to propose is the fiscally stronger countries get a greater say in how the weaker periphery run their economies.

Thursday sees the ECB monthly meeting, with another reduction in interest rates expected.

ECB head Mario Dragi has also hinted in a recent speech of large scale bond purchases by the bank.

The much softer tone suggests a deal on government budgets might be closer than the market thinks.

Keeping with all things Europe, we also have a large amount of data to digest this week including eurozone retail sales, German CPI and the closely watched ECB monthly report which will detail the size and scope of lending to European banks by the central bank.

Sterling continues to hold its ground versus the euro and Dollar despite the dire announcement by the Chancellor last week, who downgraded his growth projections for the UK economy.

The resulting changes to the UK outlook now mean the Government will not balance its books until 2016 at the earliest.

The reason for Sterling not pushing lower in the face of a worsening outlook is probably that it is the least bad option in the face of the continuing European problems and the potential for QE3 in the US.

That said the Bank of England looks set to announce an increase to its own asset purchase scheme on Thursday at the MPC meeting.

Governor Mervyn King was in very gloomy mood as his announcement the Banks financial stability report last week and it is likely that the BOE will take action this month rather than waiting for the New Year.

German Chancellor Kaiser Angela Merkel told the Bundestag that a new EU treaty was necessary to work towards a “fiscal union” in Europe. On Monday she met with French president Nicolas Sarkozy who also called for EU treaty changes.

In her own words she noted that such a step a few months ago was not even on the agenda and would have been considered crazy.

Merkel went on to say that the single currency would survive.

The markets have responded positively to the news as Merkel & Sarkozy for the moment are singing from the same hymn sheet, in addition it is perceived as an encouraging development that the crisis can still be resolved on a long term basis.

Yesterday Bank Of England governor Mervyn King strongly warned of a spiral into a systemic crisis and urged UK banks to sure up their capital reserves to act as a buffer in the event of a full blown Eurozone collapse.

The key date for the diary is next Fridays EU summit and it is likely we will see a plan from the Eurozone for its future- we certainly need to as we cannot expect to avoid a fallout without a comprehensive plan.

Reports that businesses have already commenced plans for a possible end to the Euro underlines the urgency of the situation on the current unsustainable path- it seems we are looking at a make or break scenario with closer unity or fragmentation.

The euro has weathered the storm pretty well and has been supported by recent bond buying through the ECB, global central bank action on the swap margin and the new united push to fiscal unity by Germany and France.

Next week however is a big week for the single currency.

Elsewhere the markets so far this morning have been pretty quiet.

Today we have the big one from the US in the form of non-farm payroll data, recent US jobless claims were disappointing which may dim the prospect of a good payroll number.

However a respectable number coupled with positive momentum on a plan for Europe could see some USD weakness as risk appetite increases and thus gains in EUR/USD and GBP/USD.

Last week saw significant risk aversion played out as stock markets dropped dramatically where as this week looks a little firmer. Articles in the Italian media suggest that the International Monetary Fund (IMF) is preparing a €600 billion deal for Italy in the event of deterioration in the debt crisis- this could provide market support in the early part of the week.

Further support may also come from reports in Germany that German Chancellor Merkel and French President Sarkozy are putting together a “Stability Pact” for euro countries similar to the Schengen agreement.

Nevertheless, neither story has been confirmed so as usual the prospect for disappointment is high.

The sell on risk on rallies environment is likely to persist for a while longer despite such reports.

As we end November market orders are likely to fall and liquidity is likely to thin with plenty of events and data on tap… volatility is guaranteed.

First up includes bond auctions in Belgium and Italy today and France and Spain later in the week against the background where Germany’s failed bond auction last week has added further anxiety in bond markets.

Under the spot light tomorrow will be a European Finance Ministers meeting, given the lack of steps forward on many issues especially on the subject of Eurobonds.

With risk appearing back on the menu, traditional risk currencies like the Euro and Aussie have rallied in the early part of the session.

One would expect any gain in the Euro to prove limited and weak if the European press reports are confirmed.

EUR/USD will find upside resistance around the 1.3412 level, while the risk of a downside test of support around its October 4 low at 1.3146 remains high over the coming week.

A disappointing bond auction yesterday in Germany was a reminder to everyone of seriousness of contagion across the eurozone. The reason for concern is if the core is being hit then there is no safe haven in Europe any longer.

However this may kick-start a reaction in German officials and realise that they need to act swiftly to provide solutions to the crisis.

Stock markets recovered overnight despite a huge drop in the Dow Jones, but markets remain nervous and rebound in risk assets could be brief.

Despite US data, it’s a pretty poor picture, in particular China’s HSBC November weaker purchasing managers’ indices coming in below the 50 boom/bust level.

Europe’s weaker purchasing manager indices emphasize the projection for recession while the news in Germany is both poor on the bond front and also on the data front.

A lack of liquidity due to the US Thanksgiving holiday will mean the markets are set for dramatic moves.

EUR/USD has already sustained a drop below the important 1.3500 level as even the underling strong Asian demand appears to have been pulled back.

More downside is expected but technical indicators suggest that it will be hard trudge lower, with near term support seen around 1.3285.

The near term range is likely to be 1.3285-1.3505 although given the US holiday the range may be even tighter.

Apart from the IFO attention today will focus on a meeting between Chancellor Merkel, President Sarkozy and Prime Minister Monti.

As usual expect a lot of hot air but little action. Also note there is a general strike in Portugal today protesting against austerity measures in the country.