The European Central Bank (ECB) is on another rescue mission, pouring billions of euros into weaker eurozone debt markets to protect them from quantitative easing unwinding pressure.
Déjà vu? Yes but the drama moves from Greece to Italy and the financially fragile includes Portugal, Spain and Greece – Club Med reloaded.
What is your sentiment on EUR/USD?
Vote to see Traders sentiment!
Euro crisis 2.0
By protecting Club Med borrowing costs – basically credit subsidies – can the ECB forestall a further euro plunge? Not everyone thinks the euro will take a negative hit for the moment, even if rating agency Moody’s last week slashed its outlook on Italian debt, from stable to negative.
If the US Federal Reserve and Bank of England cuts the speed of rate hikes in the next six months while the ECB is just starting, says analyst Joachim Klement at Liberum, “we expect the rate differential between the eurozone and the US/UK to narrow, which should support the euro for a while”.
Those last three words are key. Viraj Patel from Vanda Research says being short Italian bonds or BTPs will be a go-to macro trade come September. “You’ve got an obvious catalyst and an obvious event risk to trade around.”
A bad Italian election outcome – a snap election is due 25 September – where the incumbents don’t play ball with the EU could be the driver that sends the euro back to parity he says.
Any deterioration in the Russia-Ukraine war and energy crisis may also spur a EUR descent.
TPI sticking plaster?
For the moment the risk of a fresh euro crisis is being partly held at arm’s length says Capital.com FX strategist Piero Cingari, by Christine Lagarde’s all-new Transmission Protection Instrument (TPI) tool, allowing the ECB to snap up bonds of Club Med stragglers.
It’s thought the ECB sank €17bn into Italian, Spanish and Greek markets during June and July. Realistically, does the ECB think it can control inflation while failing to tighten the money supply in weaker countries?
While very much a dressing plaster the TPI tool lowers the risk, says Cingari, “that sudden rises in interest rates will have a negative effect on the debt sustainability of countries like Italy, Spain, Greece and Portugal”.
Europe’s bond market – like no other
- Money is created by the ECB though debt is issued from member nations
- The ECB has a key mandate of price stability across the euro region, useful in a crisis such as the pandemic
- However Italy’s debt levels are now higher than its GDP ratio, which triggers higher interest rates on its debt
The best of all possible crises?
Meanwhile some real-world imbalances flare: while Italy’s currency approaches lira levels it has the protection of low interest rates this time. But it’s the opposite for German savers fighting blistering inflation and energy pressures, in contrast. Quite a transfer of wealth, north to south.
Still, no band aid can disguise that the Eurozone’s macroeconomic fundamentals are deteriorating – fast.
“External accounts,” says Piero Cingari, “are already showing record-high trade deficits, and the weakening growth picture may have an adverse impact on capital flows in the coming months.”
Bond yields plus yeast
Cingari adds that S&P Global Rating expects bond yields in coming years to be much higher than since 2015.
“This will result in higher interest payments over time, putting additional fiscal strain on the eurozone’s high-debt sovereigns.”
Bottom line? “Any policy insurance against free-market forces comes at a cost – which could be the euro’s depreciation,” he warns.
CPI-sensitive
Meanwhile markets await the US CPI print as well as a German inflation update tomorrow. With easing US oil and gas prices markets are forecasting that US July year-on-year inflation will slip to 8.7%.
But core inflation, which strips out volatile energy and food prices, is expected to climb to 6.1% – which could see USD strengthen again.
Earlier EUR/USD spot stretched to a two-day high to 1.0244 – still off 4 August’s 1.0249 high – as some of the glow from the USD’s nonfarm payroll numbers dimmed.
Further reading
Source link
