Bailout Euphoria Is Evaporating

Chief markets economist Kevin Gaynor  of RBS says the E.U.’s strategy  is “Bailouts rather than integration”. It is not solving the problem, E.U.  are just throwing money at it. Marek Belke, the E.U.  head at the IMF, compare the rescue package to a dose of morphine with the purpose to stabilize the patient. The real hard stuff has yet to happen.

“What we’re seeing is everything being glued together by bailouts rather than integration. The currency is starting to turn into an average of its members rather than the Deutsche mark, which people thought it would be.”

Kevin Gaynor

Most European newspapers opened this morning with the story of euphoric market reactions, but the hangover already started to set in with the opening of markets in Asia. After the euro surged against dollar and yen yesterday, this morning the euro already fell back by 0.3% against the yen.

In addition, South European bond markets improved yesterday, but as it turned out the only buyer was the European System of Central Banks.

Market confidence has not yet returned to the bond market.

“Think differently about the place from now on,” says Kevin Gaynor, chief markets economist at Royal Bank of Scotland Group Plc in London. “What we’re seeing is everything being glued together by bailouts rather than integration. The currency is starting to turn into an average of its members rather than the Deutsche mark, which people thought it would be.

Gain Lost

The euro traded at $1.2777 as of 9:49 a.m. in Tokyo, down from a high of $1.3094 reached yesterday in the aftermath of the bailout announcement.

The currency has lost almost 16 percent since late November and is down against 15 of the 16 most-traded currencies this year.

“No one’s saying that this is easy,” says John Lipsky, the No. 2 official at the International Monetary Fund, in an interview with Bloomberg Television today.

“It’s an important step. Now let’s see what happens in other countries that need to undertake adjustment programs.” As part of the European Union’s agreement, Spain and Portugal pledged deeper budget cuts to be outlined this month.

Lipsky adds that “it was a very big step by the ECBto agree to buy bonds.

Could Go Into Reverse

The consensus comment praised the euro zone’s initiative as a courageous, but warned that structural problems have not been dealt with and could trigger more turmoil in years to come.

(See for example this comment from Peter Boone and Simon Johnson, two of the most consistent commentators on the euro zone crisis.)

Unless the EU comes up with a plausible strategy – on reform of fiscal policy, governance systems, and structural reforms – the announcement will soon be reversed completely.

Unless the EU comes up with a plausible strategy – on reform of fiscal policy, governance systems, and structural reforms – the announcement will soon be reversed completely.

“There is absolutely no evidence the E.U. is going to deliver a package with the capacity to impress investors,” the eurointelligence.com writes.

For the last ten years, the governance rules served the sole purpose of satisfying national prejudices – see for examples Merkel’s ludicrous proposals for a strong stability pact.

Betting On Further Euro Decline

Bloomberg reports that traders are now betting that the euro will resume its decline as Europe’s economic recovery trails behind that in the US and the ECB will keep interest rates low.

There is also concern that the ECB’s decision to buy bonds compromises its independence, prompting investors to demand “a higher risk or credibility premium”.

This sentiment was also expressed in a front-page editorial in FT Deutschland, which said the ECB’s independence has suffered. There is also some concern express by investors in this respect.

The ECB’s visible U-turns on collateral policy and on bond purchases appear to suggest that the central bank has had to be reluctantly co-opted into a political consensus.

Inflationary Risks

Jean Claude Trichet clarified yesterday how the bond purchasing programme is likely to work.

To sterilize the bond purchase, the ECB is considering term deposit, compulsory deposits banks would have to hold at the ECB, which has the effect of withdrawing liquidity from the system.

FT Deutschland reports that the main risk is a rise in inflationary expectation that would happen if governments do not step up their consolidation efforts, while the ECB is supporting the bond market.

The ECB decision was not without controversy internally. Jean Claude Trichet said the initiative was approved by “an overwhelming majority” on the ECB council – an implicit acknowledgment there had been opposition.

The Financial Times quotes Axel Weber saying that he viewed the step critically “even in this exceptional situation” because of its inflationary risks.

“It does not address the underlying issue – the terrible economic growth prospects of the southern euro zone countries and Ireland,” says Simon Tilford, chief economist at the Centre for European Reform think-tank. “Unless these economies can avoid deflation and get their economies growing, they have no future in the euro zone.”

European policymakers hope countries with highly indebted private and public sectors will adopt rigorous fiscal policies and structural reforms to avert the need to draw on the €440bn loan facility.

Euro Market Snap Shot

The euro is weakening against most major currencies Tuesday morning.

This is how it looks like at the moment:

EUR/USD:

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EUR/JPY:

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EUR/GBP:

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E.U. Prepared To Set Up Own Rating Agency

Europe To Fight Speculators With “Secret Plan”

David Rosenberg: “The Weirdest 20 Minutes Of My Life”

Wall Street Collapse: Did Somebody See It Coming?

Fitch Warns Of New Speculative Oil Spike

European Banks Loaded With Greek Debt

Gerald Celente: “The Great Crash Has Occurred”

A Baltic Future For Greece?

Bail Out Pyramid?

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5 Comments

Filed under International Econnomic Politics, National Economic Politics

5 responses to “Bailout Euphoria Is Evaporating

  1. VoiggaLia

    Just want to say what a great blog you got here!
    I’ve been around for quite a lot of time, but finally decided to show my appreciation of your work!

    Thumbs up, and keep it going!

    Cheers
    Christian, iwspo.net

    • econotwist

      Thank you very much!

      I won’t evaporate just yet 😉 Promise 😉

      AllTheBest
      econotwist

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