Thursday, 29 May 2014

Too Big, Too Bossy, Too Interfering

Those are the words British Prime Minister Cameron used in anger to describe the actions of the EU in Brussels.  This is in response to an European Commission demand the British must pay an extra £500M more for the additional Brussels spending.

The timing of the request is awkward, immediately following the British vote for the European Parliament.  In this election, the euro-allergic United Kingdom Independence Party (UKIP) easily beat both Labor and the Tories; the anti-EU vote and the outraged response was not confined to the UK.

National governments are furious at an increase that comes in the aftermath of EU elections victories for populist and far-Left and Right parties in Britain, France, Denmark and Greece.

"What a smart way to react to the concerns of Europe's voters, let's ask them for more money," said a European diplomat. "The commission must live on another planet if they think that Europe can reconnect with people by raiding their wallets."

So the EU elites continue with business as usual, ignoring the popular vote which favored more nationalism and less austerity.  As a consequence, the squabbles within the EU continue.

There were fundamental eurozone numbers released Wednesday which might soften the German opposition to an aggressive stimulus package.  German unemployment was expected to drop 15K but actually went up 23.9K.  This lagging indicator suggests the German economy may be slowing, a concern for Merkel and the Bundesbank.

The other significant number released was the EU M-3  which was up only 0.8%, worse than the expected 1.1% and last month's 1.0%.  The M-3 is the broadest measurement of the money supply and reportedly is an important indicator for central bankers.  EU loans to the private sector were down 1.8%.  The tepid growth in the money supply is a strong reason why the ECB must take action.

The problem is you cannot push a shovel with a string.  In the US, for example, it is rumored there is an extra $3T of bank reserves, the cumulative results of excessive QE.  If there were a demand for the money, the loans would be made.  Monetary policy alone does not fix a stagnant economy.

But the market is anticipating the ECB is going to take token action only, at the next Draghi show.  If true, the consensus is the 1.3550/1.36 level of the EURUSD should hold, and we may be witnessing one of those sell-the-rumor and buy-the-news episodes.

A feature of the market Wednesday, 28 May 2014, was the continuing collapse in bond yields.  The yield on the 10-year paper is down to 2.44% in the US, 8 basis points lower,  down 9 bp in to UK to 2.55, and down 5 bp to 1.34% in Germany. 

Is the bond market telling us the current recovery, after five years of monetary tricks, is as good as it gets and we are headed for another global slow down?

The pound sold off badly, through our initial support, to slightly under 1.67.  As we had mentioned before, the trade in the pound futures is large, and the last COT report showed the specs to be long over 50K contracts.

Click to Enlarge EUR/GBP Weekly Currency Chart

For the past three days the euro has been gaining on the pound.  This is a bounce after the euro lost over 300 pips to the pound.  Chances are there are more pound longs to be liquidated which will put further pressure on the pound.  Since the longer term outlook of the British economy appears better than the Eurozone economy we think there will perhaps come a time when we sell the EURGBP (FXE, FXP).

Since the wash-out of the pound longs may be in the initial stage, we prefer to watch and wait for the potential trade.  Too often, when I like the long-term outlook, I have jumped too soon, and then a careful analysis loses because of bad timing.

Ralph Shell, Excel Analyst
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