Saturday, 17 May 2014

Euro Banks on Broad Support

After the previous week's sharp losses in the EURUSD following a key reversal, we had felt the euro might be able to stage a modest recovery.  Such was not the case.  The weekly high was about 25 pips above last week's close - a feeble performance - and working toward the end of last week's trade, we are slightly under the 1.37 handle.

Economic data from the EU showed the economy was growing at a slower-than-expected rate.  The guesses for the 1st quarter EU GDP were a positive 1.1%, but the number fell short - only 0.9% higher - but still better than last quarter's +0.5%.  This number seemed to tilt the consensus toward a more robust ECB stimulus starting in June, something more specific from ECB President Draghi's.

While Germany continued to show solid growth, the French GDP fell to unchanged and the Italian GDP actually turned negative for the quarter.  For Italy, this lack of growth is a threat to the entire eurozone.

Italy has a population of 60.6 million, and GDP in 2014 is estimated by the IMF to be $2.1 Trillion.  This ranks Italy as the third largest economy in the eurozone, and the 8th largest economy in the world.  But there is no job creation in Italy.  Unemployment has remained above 12%, and the youth unemployment tops 40%.

This, however, is just part of the story, as revealed in The Telegraph:
Italy is wasting away month by month ... Today's headline from Italy is that unemployment has at last begun to fall, dropping from 12.8pc to 12.7pc in December.

Drill deeper and the recovery story turns to dust. The number employed in Italy has fallen by 424,000 over the last year.  The overall employment rate has fallen to 55.3, a staggeringly low level. The rate for men has fallen by 1.6 percentage points over the last year.

Youth unemployment was 41.6pc despite a tide of emigration to Britain, Germany, and beyond. The brutal reality is that Italy's human capital is still being destroyed by contractionary EMU policies. Italian industry is still being hollowed out. The hysteresis effects of skills erosion – and the failure to draw a large chunk of the next generation into the economic system at a crucial stage in their lives when they are most open to new technologies – will lower Italy's future growth rate and do lasting damage to Italy's economic dynamism.
It is unfair to place blame for the plight of the Italians on the inflexibility of the single currency. The recent survey of economic freedom by ranks Italy as number 86 in the world.  This puts Italy just ahead of Croatia and behind the Kyrgyz Republic.  Despite periodic attempts to reform, the business climate is difficult.  Corruption, a difficult labour market, and a decline in property rights, all hurt the growth of their economy, according to Heritage.  

Recent Italian population growth has been positive, but only a mere 0.3%.  As the migration from Italy continues, the population of the working age may be declining.  This will leave fewer people to pay off Italy's estimated €1.7 Trillion of outstanding notes and bills. 

The government will need to sell €470B this year to refinance maturing debt.  Recently, the yield on this debt has come down to under 3%.  The bad economic news may have spooked the bond traders.  Yield on the ten-year Italian sovereign paper slipped this week to about 2.90%, but then reversed Friday, 16th May, and traded about 3.10%.  This needs to be closely monitored in the coming weeks.  Higher rates spell big trouble for the euro zones third largest economy.

The EURUSD closed poorly, under 1.37.  In the process, the pair has violated a multi-week trend line.  The COT report released Friday afternoon showed the large specs have dumped their long and flipped to the short side of the euro.  Unless we get a weekend surprise, the set up for a further bear move is in place.  The first support should be around 1.3620.
Ralph Shell, Excel Analyst
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