MacroScope

Euro will rally further, say the most accurate FX forecasters

The euro will rise even more, according to some of the top foreign exchange strategists who accurately predicted resilience in the common currency over the past year.

If it does, policymaking will get even tougher for Mario Draghi and the European Central Bank, who are already grappling with inflation at a four-year low and well below the bank’s target.

In 2013, the euro was the best performer among the majors, gaining almost five percent against the dollar, wrong-footing the consensus view in Reuters polls during that period.

The latest poll suggested once again that the euro is set weaken over the coming year in anticipation of a dollar rally as the U.S. Fed is widely expected to end its massive stimulus programme and hike interest rates next year.

While that makes sense as a logical explanation for currency moves, this course of events is so well understood by markets that it’s hard to imagine how anything other than a much earlier interest rate hike isn’t already priced in.

Japan-style deflation in Europe getting harder to dismiss

To most people, the idea of falling prices sounds like a good thing. But it poses serious economic and financial risks – just ask the Japanese, who only now finally have the upper hand in a 20-year battle to drag their economy out of deflation.

That front is shifting westward, to the euro zone.

Deflation tempts consumers to postpone spending and businesses to delay investment because they expect prices to be lower in the future. This slows growth and puts upward pressure on unemployment. It also increases the real debt burden of debtors, from consumers to companies to governments.

In many ways, policymakers fear deflation more than inflation as it’s a more difficult spiral to exit. After all, interest rates can only go as low as zero and if that doesn’t kickstart spending, they’re in trouble. Again, just ask the Japanese.

Will rounding cents bring euro zone down?

The 18-country euro zone has had a rough ride in the past 6 years, and even with the glimmers of good news reaching the darkest corners of the debt crisis, the European Central Bank has been anything but ready to sound a crisis-over siren.

Right after ECB President Mario Draghi warned against undue optimism, the central bank has identified a new threat to the common currency’s integrity – rounding up or down small change.

Belgium plans to allow retailers to round 1 and 2-cent coins to the closest five cents, in a similar fashion as Finland and the Netherlands already do. But the ECB had harsh words against such going-it-alone moves, published in a legal opinion published on its Internet site.

Euro zone stock market investors: “Crisis? What crisis?”

European shares will be the best performers next year, according to the latest Reuters poll of more than 350 strategists, analysts and fund managers. Frankfurt’s DAX is already up nearly 20 percent this year and is forecast to rally another 10 percent in 2014.

But the experts in foreign exchange that Reuters surveys each month are also saying that the euro, just above $1.37, and not far off a two-year high against the dollar, will fall.

While both predicted outcomes may turn out to be true, the problem is that the flow of foreign money into European stocks is one of the reasons why the euro has remained so strong.

Hopes for a weaker euro looking more like fantasy

Hopes that the soaring euro will eventually fall and help the economy with a much-needed export boost for struggling euro zone nations are looking more and more like fantasy.

The collective talk about its inevitable drop is beginning to sound much like the drum-beat of opinion lasting more than half a decade that said the yen would fall while it stubbornly marched in the other direction.

Only the most spectacular fusillade of Japanese central bank cash in history managed to turn the situation around, and even now the yen is barely trading much weaker than the most conventional of predictions a few years ago.

Moments difficiles

Breaking news is S&P’s downgrade of France’s credit rating to AA from AA+ putting it two notches below Germany. Finance Minister Pierre Moscovici has rushed out to declare French debt is among the safest and most liquid in the euro zone, which is true.

What is also pretty unarguable is S&P’s assessment that France’s economic reform programme is falling short and the high unemployment is weakening support for further measures. There’s also Francois Hollande’s dismal poll ratings to throw into the mix.

As a result, medium-term growth prospects are lacklustre. Euro zone GDP figures for the third quarter are out next week and France is expected to lag with growth of just 0.1 percent.

ECB rate cut takes markets by surprise – time to crack Draghi’s code


After today’s surprise ECB move it is safe to forget the code words former ECB President Jean-Claude Trichet never grew tired of using – monitoring closely, monitoring very closely, strong vigilance, rate hike. (No real code language ever emerged for rate cuts, probably because there were only a few and that was towards the end of Trichet’s term.)

His successor, Mario Draghi, has a different style, one he showcased already at his very first policy meeting, but no one believed to be the norm: He is pro-active and cuts without warning. Or at least that’s what it seems.

Today’s quarter-percentage point cut took markets and economists by surprise.

It’s all Greek

The EU/IMF/ECB troika is due to return to Athens to resume a review of Greece’s bailout after some sparring over budget measures.

Greece’s president and prime minister have said they will not impose any further austerity measures and hope that their ability to run a primary surplus will persuade its lenders to cut it some more slack on its bailout loans to make its debt sustainable. The EU and IMF say there will be a fiscal gap next year that must be filled by domestic measures, be they further wage and pension cuts or tax increases.

We had a round of brinkmanship last week with EU officials saying they weren’t going to turn up because Athens had not come up with plausible ways to fill a 2 billion euros hole in its 2014 budget. But on Saturday, the European Commission said the review was back on after the Greek government came up with fresh proposals.

Italy versus Spain

Italy will auction up to 6 billion euros of five- and 10-year bonds after two earlier sales this week saw two-year and six-month yields drop to the lowest level in six months. Don’t be lulled into thinking all is well.

After Silvio Berlusconi’s failure to pull down the government, Prime Minister Enrico Letta has some time to push through economic reforms, cut taxes and spending. But already the politics look difficult and the central bank said yesterday that government forecasts for 1.1 percent growth next year and falling borrowing costs were overly optimistic.

Bank of Italy Governor Ignazio Visco and Economy Minister Fabrizio Saccomanni will speak during the day.

The Italian Job

Italy has dropped out of the spotlight a little following the protracted political soap opera surrounding Silvio Berlusconi. But it remains perhaps the euro zone’s most dangerous flashpoint.

Prime Minister Enrico Letta now has some time to push through economic reforms, cut taxes and spending in an effort to galvanize activity. But already the politics look difficult.

Italy’s three main unions are to strike over the government’s 2014 budget plan. Former premier Mario Monti resigned as head of his centrist party after it supported the budget which he viewed as way too modest, lacking in meaningful tax cuts and deregulation.