Fade Euro Resilience

The EU Summit may have ended, but the European debt crisis has most certainly not. What does it really matter to current investors, under mark-to-market pressure that the European officials have agreed to some wording changes in their Treaty to allow for a permanent crisis facility at the end of 2013?  Even the aid packages for Greece and Ireland have not stabilized their situations as Moody's 5-notch cut in Ireland's debt rating to Baa1 and a negative outlook today illustrates.

Recently Moody's also put Greece (and Spain) on credit watch for a possible downgrade. European officials do not appear to have taken any fresh initiatives to address the current pressures. It is disappointing and there is a price to pay for that disappointment.

In the first instance the high debtors in the union will pay higher yields and all the ramifications in terms of debt serving costs and growth retardant. It also would seem to increase the likelihood that investors judge Portugal as ill-positioned to stand alone. While the data is far from transparent, it appears that Portugal has about 11 bln euros of maturing sovereign debt in Q1 11. The ECB's efforts may be helping to keep rates from rising too much, but there is limits on its ability as rise in Irish and Greek bond yields indicate.

Other euro zone countries, including Spain, Italy and Belgium have relatively large sums to fund in Q1 11 as well. In about a month's time, a newer bond issuer will appear on the stage. Reports indicate that the EFSF is preparing a 5 bln euro offering in the second half of next month.

More immediately, on Monday the market will learn the size of the ECB's recent bond purchases. The market has been generally disappointed with the size of the the recent bond purchases even though they increased from a low base, but impressed the impact. Next Wednesday the ECB will offer an unlimited amount of 3-month money.

This could catch some market participants who don't follow the minutia unaware because the next day the are around 200 bln euros or repos expiring, including the last of the 12-month funds. Interpolating from prices in the forward market, there is increasing concern about dollar liquidity, where non-US banks are swapping euros for dollars.

The euro has been quite resilient to developments today.  It is true that the German IFO is at record highs.  But this was already largely hinted at by the robust manufacturing PMI earlier in the week and the strength of the German economy is well known and appreciated.  Moreover, the ECB's monetary policy setting may be too easy for Germany.  Liquidity and year-end thin markets and position squaring may dominate until the new year. 

I suspect the euro bounce in Asia and Europe will be short-lived and look for the North American market to sell into the euro's gains today.  The dollar is stronger than the euro's performance would suggest.  It is slightly firmer against the dollar-bloc and sterling, and essentially flat against the yen.