WISE MONEY

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.

Eurozone leaders once again put off decisive action to the region dent problems leaving the markets to trade and rumours and comments. The crisis, which threatens to throw the world into a new recession, has been the only subject of note for traders and investors as the markets remain volatile, but over a small range.

The summit, between 17 euro nations, led to the agreement that the bailout fund would be leveraged up to €1 trillion, half the €2 trillion the markets have been looking for.

This agreement is only in words though and no official number or method for achieving it has been announced.

The disagreements to derive over exactly how these funds will be raised and also the size of the haircut that banks and institutions will have to take on any Greek bonds they own.

The IMF was said to favour a 70% cut while the owners of the bonds are struggling to get above 40%.

Further chaos added came from Italy where politicians came to blows as they discussed austerity cuts for the country.

Rumours that Prime Minster Silvio Berlusconi will resign by the end of the year added fuel to the fire and the worries that Italy could be heading the way of Greece has grown severely over the last few weeks.

French President Nicolas Sarkozy and German Chancellor Angela Merkel have been meeting with banks in order to thrash out details of haircuts and asking the banks to raise funds.

France’s 4 largest banks are expected to raise €8.8bn with 13 German banks bring €5.2bn.

Also, Spain’s 5 largest banks will raise €26bn leaving 5 Italian lenders needing to produce €14.7bn.

This plus other banks across the Eurozone will raise a total of €106bn, with Britain’s lenders not raising anything to the total.

This capital will be used as reserves to cover the losses from any write-downs on sovereign debt held with each institution.

Until these agreements are signed, sealed and delivered with the fine print read through, we are no closer to being out of the woods to last week.

Money markets have held steady as they await details of an agreement to resolve the eurozone debt crisis.Stock markets and the euro rose in early trading before falling back.

Although a weekend summit of eurozone leaders was inconclusive, the outline of a deal was agreed, with a summit to finalise details set for Wednesday.

Eurozone leaders agreed to force banks to protect themselves against future losses, and to increase the firepower of the single currency’s bailout fund.

Following a robust rally in Asian markets, European stock markets had been up 0.5%-1% in the first hour of Monday trading on the apparent progress at the talks.

Asian markets had been lifted by positive data from China and Japan, as well as the apparent progress in Brussels.

But European markets later fell back, and by mid-afternoon trading the Cac 40 index in France and the German Dax were both fractionally lower, while London’s FTSE 100 was up just 0.3%.

Market sentiment was not helped by industry surveys released during the morning that suggested the French and German economies are still struggling to avoid recession.

However, key points of disagreement remain.

France had hoped that the European Central Bank (ECB) would support the EFSF, by providing it with loans that could increase the fund’s total capacity to 2tn-3tn euros.

But this idea was blocked by Angela Merkel.

Instead, governments are expected to agree that the EFSF can help out troubled eurozone governments such as Italy and Spain by providing partial guarantees to investors and banks who lend them more money.

There was also disagreement over the extent of losses that should be imposed on Greece’s lenders, with Germany seeking a 50%-60% haircut.

The ECB opposes any such increase, according to a footnote in an internal document on the Greek economy leaked over the weekend.

There are fears that a unilateral default by Greece – such as a debt write-off without lenders’ consent – could have unforeseen consequences, for instance by triggering payments under credit derivative contracts.

Another unknown element in talks is whether and how much non-European countries may provide support.

The price of copper – an indicator of market sentiment over the global economy – rose 6% in Shanghai trading. But after the markets opened in Europe, the rally lost some of its lustre.

The euro followed a similar pattern, rising half a cent against the dollar, before dropping back. By mid-afternoon in Europe it was trading at about $1.386, down 0.2% for the day.

Eurozone finance ministers are meeting to discuss the region’s debt crisis in the first of several summits to be held in Brussels over the weekend.On Saturday, ministers from all 27 EU countries will hold talks. EU leaders will then gather on Sunday and at an extra meeting on Wednesday.

They need to agree a second bailout for Greece, how to recapitalise banks, and a stronger bailout fund, before Greece can then be allowed to default- and there still appear to be deep divides between France and Germany.

In particular, the two need to agree on how to increase the firepower of the eurozone’s bailout fund, the European Financial Stability Facility (EFSF), from its current 440billion euros ( £383 billion).

France has proposed turning the EFSF into a bank so that it could borrow from the European Central Bank (ECB), but Germany has refused to sanction such a move, arguing it would compromise the ECB’s impartiality.

The German government has also promised its taxpayers that its contribution will not go above 211bn euros so is looking for a way to increase the size of the fund without increasing the liabilities of German taxpayers.

Despite no apparent movement on the deadlock, markets were trading higher, with the leading indexes in London, Frankfurt and Berlin all up between 1.5% and 2.7%, while US markets also rose at the start.

Jean-Claude Juncker, the chairman of the eurogroup and the prime minister of Luxembourg, said the delay to a deal portrayed a “disastrous” image of the eurozone to the rest of the world, adding that it was not necessarily just France and Germany that had differences of opinion.

This crisis has underlined that the EU, in large part, remains a Franco-German union. The other members of the eurozone appear as bystanders whilst the French and German leaders determine the fate of their currency.

A deal on the euro had been expected to be signed on Sunday, but France and Germany said they would not be able to reach an agreement by then and announced that leaders would meet again on Wednesday.

Sunday’s summit had already been delayed from 17-18 October because more time was needed to finalise a plan.

A second hurdle in the way of any rescue plan is that negotiations have not yet begun properly with private sector lenders to Greece on a further reduction of what the Greek government will repay them.

Banks have already agreed to take a 21% loss, or “haircut”, on their loans to Greece but there is growing pressure for them to accept higher losses.

Previous disagreements between France and Germany about the bailout plans have centred on how much the private sector would have to contribute to any package.

The president of the European Council has said that a summit of EU leaders to discuss the eurozone debt crisis has been delayed by a week.Herman Van Rompuy said more time was needed to finalise a plan to give money to Greece and bolster debt laden banks.

The summit, originally planned for next Monday and Tuesday, will now start a week later on 23 October.

European regulators and the leaders of Germany and France have been engaged in intense talks for several days.

Mr Van Rompuy said in a statement that the delay will allow the EU “to finalise our comprehensive strategy on the euro area sovereign debt crisis covering a number of interrelated issues.”

The 27 nation EU, and in particular the 17 country eurozone members have found themselves under growing market pressure to finally act.

Fears that Greece and other highly indebted countries will default on their debts, and cripple the banks that hold their bonds, have sent shockwaves through financial markets.

On Sunday, German Chancellor Angela Merkel and French President Nicolas Sarkozy said they were close to agreeing a comprehensive new package to ease the eurozone’s debt crisis. However, they gave no details.

Mr Van Rompuy also said he had asked for an additional meeting of EU finance ministers ahead of the 23 October summit, so they can lay the groundwork for the leaders’ decision.

A sense of optimism looks to be filtering through the money markets at present. This derives from hopes that the European authorities will be able to ring fence Greece and steer clear of a much deeper and wider contagion to other eurozone peripheral countries than has already taken place.

This may involve a European version of the US Troubled Asset Relief Program.

A variety of other methods are being considered including covered bond purchases from the ECB, provision of 12 month liquidity by the ECB, a policy rate cut, banking sector recapitalisation and increasing the size of the EFSF bailout fund.

The consequence of such rumours have provided a slight Euro rally and asset markets however there is a long way to go before hopes turn into action.

The next few weeks will be essential to establish whether a firmer base to sentiment and the EUR can be established and markets will turn their attention to a meeting of eurozone finance ministers on October 3 and the European Central Bank on October 6.

Meanwhile national votes on changes to the EFSF bailout fund will continue with Germany’s vote on today.

While the vote is likely to pass it may draw attention to divisions within Chancellor Merkel’s party.

Without doubt, there is no room for any more distress especially given that the plans agreed by European officials in July have yet to be implemented.

If there is no solid action over coming weeks the EUR will come under renewed strain and indeed the risk is still heavily skewed towards more EUR weakness given the various disagreements between officials.

Nonetheless, the improved mood in the short term will likely help prevent the currency from sliding further for now and a base appears to be forming just under 1.35 against the USD.

The huge gains in stock markets around the world yesterday were not mirrored in by corresponding moves in the currency markets, which saw only modest gains for Sterling against the Dollar and Euro. European politics continues to drive sentiment between euphoria and despair as first a Greek deal looked to have been reached, before this morning we find out there is still huge disagreements between member states over details of plan.

The Euro ship is lurching from side to side as traders and investors rush from one side to the other on the back of every new announcement.

On one side German officials have been joined by other creditor nations, Finland and the Netherlands, in calling for the private sector to take on a greater slice of any write down.

On the other side sits France, who are desperately trying to keep losses away from their banks, who only just survived a recapitalisation after heavy falls in their share prices in the past few weeks.

With a lack of Sterling data this week and with the Bank of England meeting coming up next week, the MPC have all hands to the pump trying to warn the market of another round of quantitative easing coming either next month or more probably the month after.

Several members have indicated that they may join Adam Posen in voting for further monetary easing if the economic picture continues to deteriorate.

Careful not to push market expectations to far, the MPC hawk Andrew Sentence has also been in the press stating worrying about the inflationary effects of another round of QE.

What the Bank is making clear is the clear change of stance from a neutral wait and see, to a much more dovish tone and for Sterling that looks like it will be enough stall any sort of recovery against the Dollar in the near term.