European Sentiment Remains Under Pressure, But US Debt Concerns Are Building(23-Dec-2011)

Eurozone sentiment is never elevated for long these days, and that was especially true yesterday during the ECB’s long-term refinancing operation (LTRO). The ECB was offering 36 months loans at this tender, and allotted a whopping EUR 490bn – far more that the consensus estimates of EUR250-350bn. The operation was seen as an opportunity for European banks to meet their long term funding needs and provide some buffer as they manage their deleveraging; but after an initial euro rally, the currency collapsed all the way back down during the afternoon session. Eurozone developments are now following a very predictable pattern; early optimism is followed by widespread scepticism – and the elapsed time between the two phases is shorter with every successive attempt made by policy makers to salvage the Eurozone model.   Perhaps the only saving grace for the euro is the fact that ratings agency Fitch has reignited discussion about the US debt situation, distracting some of the scrutiny away from European targets. Thus far, the dollar has managed to benefit from the market’s preoccupation with European doomsday scenarios, and the monstrous budget deficit that the US is carrying has perhaps not garnered enough of the attention. That may all change very soon. Fitch warned that unless the US can reduce further its budget deficit by late 2013, it will face a downgrade. Reducing the budget deficit seems like a tall order when seen in the light of this summer’s frustrating political wrangling during the discussion to raise the debt ceiling. If political headwinds continue to hamper US progress, then it is likely that negative sentiment and media focus will build momentum in 2012 – a scenario that is unlikely to benefit the dollar.   Against this backdrop, sterling is looking like it could evolve into a new breed of safe-haven in the coming year. Yesterday’s BoE minutes stated that the balance of risks in the UK were largely unchanged from the month prior – an assessment which is remarkable considering the numerous central banks who have been compelled to cut interest rates this month due to a deteriorating outlook (including the RBA, ECB, Norges Bank and Riksbank). David Cameron’s veto on financial transaction taxes is looking like an increasingly smart move, and fears of UK isolation with the European Union appear overdone. Investors looking for a safe-haven in the coming year are finding the euro in crisis, and the dollar facing a debt time bomb of its own. The other traditional safe-havens, the yen and Swiss franc, are subject to central bank intervention which limits the appeal of holding either currency. Given this landscape, we expect the pound and Scandinavian currencies to flourish in the new year. Where the pound has a particular edge, is that the liquidity available is far deeper that for either the Norwegian or Swedish currencies; and during times of crisis, liquidity becomes a prized asset in itself.


By

M.Zohaib Gadit

Forex Trading Consultant