I made the following predictions back in December. Things have evolved in ways such that I am close to being completely right or completely wrong on both of them.
-The Federal Reserve will become active in the foreign exchange markets. At different times of the year they will both buy and sell dollars. Their objective will be stability. These efforts will be referred to as “smoothing operations”.
-There will be no breakup of the Euro. Greece will not pull out. The strong members will provide some relief for the weak. But the problems will not go away and the possibility of some form of two-tiered Euro will be a matter of open discussion. It is in this context that the Fed’s FX intervention takes place.
In my opinion the decline of the Euro in 2010 has be orderly, up to the last week. Two "big figures" on any given day is part of the adjustment process that is necessary due to the changing fundamentals. That is not disorderly. But we have lost five big figures in a week. That is a big adjustment, but is still not the Central Banker's definition of a market that would necessitate coordinated intervention. But it is getting close. A few more days at the current pace would likely get us to the point where some action may be required.
The problem is that the Euro/$ is the "go to" trade that reacts to every bit of bad news that is coming out of the EU. I am not sure if the Euro is falling because Spanish bonds are in the crapper or if Spanish bonds are getting hit because the Euro is so weak. If the deep thinkers at the EU central bank are in the later camp then they must be itching to react. Everything they have built for the past 20 years is coming unglued. They are unlikely to go down easy.
I dismiss the news/rumor/importance of the BIS being in the market. If something is going to come it will arrive with a bang and it will not be subject to any guesses. There will be clear statements by the ECB that they have, “Acted decisively to stabilize markets”. They will sell 10-30 billion dollars into the market over a few days. That is not that big an amount in the FX markets, but it will have the effect of re-establishing the notion of “two way risk”. It has been far too easy to make money shorting the Euro. They need to change that risk/reward equation.
This possible action could take a number of forms. Should it happen it would look like one of the following:
A) The EU Central Bank draws down swap lines at the Fed and sells dollars for its own account. This is the “Go it alone” approach. It will not work. It will look like a weak effort that does not have the support of the other central banks. It will fail in short order.
B) The ECB and the Swiss National Bank would intervene jointly. The Swiss would buy Euros and sell the CHF. (They love to do that, but have been bashed by the market in the past). While this approach would be better than A, it would not get the job done.
C) The Bank of England joins in with the ECB and the Swiss. This would be a hell of a party, and probably would reestablish a two-way market. But I don’t think it will happen. There is too much election pressure for the BOE to get involved, unless:
D) The Fed joins the festivities. That would be decisive, and with the US cover the Brits would get in the game.
A and B will end badly, C will not happen. Only D has a chance of buying two to three months to address some of the problems. At best this means by the end of the summer we will be back at it.
It is equally possible that the global CBs will do nothing and the Euro makes a beeline to 1.10. That approach will end badly as well. My prognostications will not come true. If the Euro was to collapse, Greece would be forced out of the Euro Zone, and it would be followed in short order by a sharp decline in economic activity for 500mm people.
I made another prediction back in December. If A, B or the “Do Nothing” plan are in the future, then I think this one will come home:
Taken from Bruce Krasting
Thursday, May 6, 2010
Tuesday, May 4, 2010
The ECB IS Printing
The ECB has been running its printing presses overtime, and it now looks like the presses are going to be running 24/7. The debt of Europe is now being monetized, which basically means that if a country can't pay what it owes - viola! The ECB will just print more.
Europe's commercial banks have been able to take the Greek bonds it buys to the ECB and swap them for cash that the ECB prints. This is the indirect monetization system - literally the printing of new money to pay old debts. Before, the ECB's policy was to accept Greek bonds as collateral for cash as long as at least one credit rating agency maintained an investment grade rating on Greece.
Some thought that the ECB would actually toughen their collateral rules in the wake of the debt crisis and make it more difficult (and expensive) for the banks to trade their bonds. But then came last week's downgrade of Greek government debt to junk status by Standard & Poors. The ECB's response? It actually relaxed its collateral rules and will now accept Greek debt no matter how low Greece's credit rating goes.
No one knows exactly how much Greek debt has been bought by Europe's commercial banks, because the numbers are not made public. Also unknown what would happen with this bond-for-cash- swaps should Greece ever default on its obligations. For example, can the ECB hold the banks accountable and force them to reverse these swaps (i.e. return the cash received from the ECB for Greek debt)?
Of course, the situation goes way beyond Greece because the implication that is that any country (Portugal, Spain, etc.) that finds it too difficult and expensive to sell bonds into the market will also have its debt monetized by the ECB. In other words, the ECB, with its relaxation of collateral rules, has basically announced that it will print as much money as necessary, or, as much as it can before people decide they’ve had enough and abandon the euro altogether.
We’re actually starting to see this already because the euro is declining not only against other paper currencies but against gold as well. In fact, all paper currencies have been, and will continue to, devalue relative gold.
I said last week that the euro is a doomed currency and that I expected to see it decline to the lower 1.20’s as the year progresses. With the ECB now on a dedicated mission to monetize the debt of Europe, what’s likely to happen is that my downward target will need to be adjusted
Europe's commercial banks have been able to take the Greek bonds it buys to the ECB and swap them for cash that the ECB prints. This is the indirect monetization system - literally the printing of new money to pay old debts. Before, the ECB's policy was to accept Greek bonds as collateral for cash as long as at least one credit rating agency maintained an investment grade rating on Greece.
Some thought that the ECB would actually toughen their collateral rules in the wake of the debt crisis and make it more difficult (and expensive) for the banks to trade their bonds. But then came last week's downgrade of Greek government debt to junk status by Standard & Poors. The ECB's response? It actually relaxed its collateral rules and will now accept Greek debt no matter how low Greece's credit rating goes.
No one knows exactly how much Greek debt has been bought by Europe's commercial banks, because the numbers are not made public. Also unknown what would happen with this bond-for-cash- swaps should Greece ever default on its obligations. For example, can the ECB hold the banks accountable and force them to reverse these swaps (i.e. return the cash received from the ECB for Greek debt)?
Of course, the situation goes way beyond Greece because the implication that is that any country (Portugal, Spain, etc.) that finds it too difficult and expensive to sell bonds into the market will also have its debt monetized by the ECB. In other words, the ECB, with its relaxation of collateral rules, has basically announced that it will print as much money as necessary, or, as much as it can before people decide they’ve had enough and abandon the euro altogether.
We’re actually starting to see this already because the euro is declining not only against other paper currencies but against gold as well. In fact, all paper currencies have been, and will continue to, devalue relative gold.
I said last week that the euro is a doomed currency and that I expected to see it decline to the lower 1.20’s as the year progresses. With the ECB now on a dedicated mission to monetize the debt of Europe, what’s likely to happen is that my downward target will need to be adjusted
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