Relief from an agreement and headache from what is to be agreed

Eurusd Trader

Junior member
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European leaders will meet this evening to try to wrap together agreement – which – they might be able to do – or they might not. Further delays cannot be excluded – as distances between the parties are substantial and fundamental. The ultimo deadline is in reality November 3-4 here in South of France. EU leaders simply can’t turn up in that meeting without an agreement.

So what are they wrangling about? A lot – to say it simple – and it’s not about cosmetics.

To the heart of the problem is the role of the European Central Bank – who has been an active player on the EU debt pitch throughout the last two years. France wants ECB to continue being an active buyer of bonds to reassure some confidence and strength in that market. Germany doesn’t think ECB should do so.

Two important questions arise from this: The first is whether member states should be able to tell ECB what to do or not to do? We are talking about the independence of the central bank which the Germans set high – and the French not so high. The second is whether being an active player in the bond market today is more of a fiscal activity than the strict monetary role the central bank should have. I mean – we all know why ECB is doing this. If they had not been as active as they have been throughout this summer, Italian and Spanish bond markets would likely have tumbled.

Since Monday when EU leaders last met – there have been talks with the banking sector – another player on the EU debt pitch. In July banks agreed to voluntary haircuts of 21% of Greek debts. Now they face the prospect of 50-60%. And they don’t like it. They take a tough stand as they know that EU is not going to let Greece go bust – but instead will pump more money into the country, preventing Greece from defaulting. Continuing doing so and we will never get to the root of this problem.

The original plan was for EU finance ministers to meet today ahead of heads of governments. That meeting was cancelled yesterday – and for whatever reasons they have – this was not a good sign.

And if you think EU outlook is bad – not a lot of comfort is seen on the other side of the Atlanatic either.
Yesterday we had US consumer confidence out at almost a chocking bad figure - the worst seen since 2009. Richmond Fed manufacturing was also disappointing. Still – markets took a muted reaction to these figures. Are we getting a bit immune to bad news?

EURUSD has been pretty “deadlocked” over the last hours and likely will remain so for most of the day – unless we get leaks about what is going to be the likely outcome.

Until this evening we have some important indicators – but neither of them is going to be of any influence today. It’s all about Brussels this evening:

• ECB publishes its bank lending survey
• German consumer prices
• US durable goods
• US new home sales
• Reserve Bank of New Zealand rate decision
• And – overnight - Bank of Japan rate decision

On a “normal” day markets would have paid attention to these data – today they are likely going to be ignored.

I see only two possible outcomes to the Brussels meeting this evening.

1) They schedule another meeting as they can’t agree to the main questions on the table. If they do so – there might be some disappointments – but a third meeting has to come fast – as all this mess has to be sorted out before the G20 meeting on November 3-4. They simply can’t face this meeting without a plan which they can present and get approval for among all G20 nations.

2) There is an agreement – and it is likely “the German” one. What this implies is that ECB will be a more “neutral” part to whatever is going to happen in the future. Less of bond purchases and not the institution to provide funding to EFSF. Then they will agree on a limited cash injection – just enough to keep the banking sector afloat with a capital ratio of 9%. The figure might not be fully settled as it is depending on an exact figure to be agreed with the banking sector on a Greek haircut. This might trigger 1) or they manage to settle the figure today. In reality – an agreement along these lines will keep the boat floating a bit longer – until Greece again needs more money or there is another country in acute trouble. Then we are on to discussions again – almost back to square one – but in deeper trouble than today. An agreement along these lines – the only likely one – if an agreement at all is to be reached, is not a solution – it’s all about gaining more time.

The solution would have been to agree a guarantee for all sovereign debt – with the exemption of Greece which should make a substantial haircut. The guarantee should have been in the size of 2 trillion euros – for existing as well as future debt. They should just open their pockets – to show strength. They have that strength as European central banks – combined – sit on 10 billion euros of assets.

They should do it as a guarantee – and they should do it big. By leaving other G20 countries – as well as markets – in no doubt about their willingness as well as their capability – to remove uncertainty, they will get investors from all over the world to participate in bond purchases and recapitalisation of banks. Think big, act as a winner and everyone will applaud you and follow you. Deep pockets would have been opened everywhere.

Instead – we possibly get an agreement – which will excite us no more than that it was one possible to reach. We might see a small relief rally from this. But tomorrow headache will hit us again – and then we are back to the same mess which has poisoned markets for the last 20 months.

EURUSD will follow equities like tandem. “Risk on” and “risk off” will still set the moves – and nothing has really changed.

Over the coming sessions I will look upon EURUSD this way:

• Until we know what the outcome in Brussels will be, not a lot will happen to the pair. The exemption might be rumours and leaks today – causing some minor volatility.

• On a decision to set a third meeting, expect a small drop – but not a big one – as a third meeting would have to come fast.

• On an agreement – almost regardless of what is agreed – expect a short lived spike – but also that one to be limited in size. It’s a relief – but more equal to pissing in your trousers to keep warm. A short lived effect.

• Later on I will trade the pair as for most of this summer – based on “risk on” and “risk off” daily scenarios. And the first one would likely be to hammer the pair a bit – after it’s small sign of relief today or tomorrow.

We have to take it step by step – day by day. It’s how markets work when politicians mess things up. It’s always been like this – and it likely will never change.

Play it cautiously and have a nice day.
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