THE PATIENT IS STABLE

By Andrew Wilkinson at IB:

The question is not whether the €750 billion European loan program is big enough to steady local government bond markets, it’s really a question of what implications the deal creates ahead. The euro is once again on the back foot this morning and has fallen from its reaction high reached after the package was announced. An IMF director addressing a conference noted that the plan was no panacea and was really a dose of morphine sufficient to stabilize the patient. Investors now fear the consequences of the stability measures will leave European monetary policy in neutral gear while disabling fiscal policy for an extended period. Such a policy mix draws attention to a possible growth rift between the U.S. and the Eurozone and at its worst, would conspire to dramatically slow the global economy.

Euro – It’s hard to say that the European bond purchase program has the problem licked. According to ECB President Trichet, this part of the plan did not meet with consensus agreement among the individual central banks. Chief amongst them was Germany’s Bundesbank headed by Axel Weber. Today he told a leading domestic journal that the plan to purchase government bonds carried “significant risks.” The morning-after tone in today’s trading carries plenty of investor questions about the outlook for the euro. The unit slipped to as low as $1.2667 in recent New York trading, while against the yen it pared yesterday’s gains to ¥116.91.

With European growth expected to trail U.S. growth by 1.5% in 2011 on analysts’ current forecasts, the inability to maneuver courtesy of frozen fiscal policy means monetary policy remains the only solution. And judging by Japan’s experience such a limited set of policy options is no good thing. But now the question becomes whether a deteriorating exchange rate becomes sufficient to heal glaring growth rift. In other words a weaker euro is of great use to the healthy manufacturing base of the core of Europe, where arguably fiscal policy retains some degree of flexibility. How far does the euro need to fall before investors work this out?

British pound – The political risk associated with the British pound rose a notch yesterday when the Labour leader and Prime Minister Gordon Brown announced he’d step down. This allowed for a potential deal between Labour under a new leader and the Liberal Democrats who hold the balance of power. Constructive talks with the Conservative party who won most votes in the election must now be on the rocks. The Liberals are holding out for political reform on national ballots that would see them gain strength in the future as the third political party. The current voting system fails their cause. Their leader Nick Clegg is apparently prostituting his party’s support to form a government in exchange for a national referendum on the issue. If the situation drags on, expect the pound to suffer. But a swift agreement and formation of a majority united behind a need to take remedial deficit action would quickly steady the pound. The unit today slipped to $1.4721 before rallying hard to $1.4811.

U.S. Dollar – Early in the New York day stock market futures were already indicating that not all of yesterday’s surge in the global stock market rebound is likely to stick. The dollar index is once again higher as investors dwell on the prospects for that widening rift between European and American rates of growth.

Aussie dollar – Signs of voracious Chinese growth and the return of euro woes harmed the Aussie today, which fell to 89.39 U.S. cents. While Chinese demand is enough to provide rocket fuel for the Aussie dollar it also turns lethal in excess, which is precisely where investors seem to be stuck. Back in November last year the Shanghai stock index reached its cycle high. After a string of poor performance the benchmark today stood 21% lower than that peak, indicative of an official bear market.

Booming Chinese export growth of 30% and import growth of 50% look great alongside retail sales growth of 18.5% and an April jump for industrial production of 17.8%. The danger is, however, that accompanying property price gains of 12.8% and a return to the highest consumer price index reading in 18 months will force the authorities to either tighten monetary policy or allow the yuan to rise.

Canadian dollar – The range for the Canadian dollar is pretty tame given the tumble in the euro. Resurgent gold prices are partially offsetting the decline in crude oil and the rally in the dollar. The loonie currently buys 97.49 U.S. cents.

Japanese yen – The Japanese unit flexed its muscles once again overnight reaching a high against the dollar at ¥92.21, although has lost some of its impetus as the dollar picks up steam to ¥92.69. It’s also rising broadly against and is chalking up gains against the euro, British pound and Aussie dollar.