Austerity Fatigue

To add to the euro’s intrigue
Now there’s austerity fatigue
Two Portuguese Mins
Much to their chagrins
Said this is becoming bush league

Austerity fatigue is the term of the day. It is being blamed for the Portuguese government’s problems as coalition members are finding it difficult to continue to support the government’s efforts to shrink itself, thus leading to the resignation of two Ministers, including FinMin Vitor Gaspar. The key concern is that if Portugal seeks a renegotiation of its bailout terms, what kind of effect will that have for the other recipients of Troika ‘love’. In the meantime, Chancellor Merkel continues to campaign to be re-elected and is trying to show her compassion for the suffering periphery while burnishing her financial bona fides. Of course there is a solution to these problems, and that is for the weak links in the euro to exit. Once again I ask, do you think that Greece would be worse off now (it being in the 6th year of its Depression) than if it had just jumped ship at the beginning and gone back to the Drachma? The peripheral countries do not have the ability to adjust their economies sufficiently to be able to live with monetary policy and a currency based on German requirements. They never will, and will suffer for a very long time unless they accept that reality. As such, while the periphery remains part of the euro, the euro will always have a fundamental weakness.

While it’s not universal, the dollar is generally stronger this morning after a series of events have called into question the rosy picture trying to be painted by global financial authorities. In no particular order we have had:
1) The two Portuguese ministers resign from the government as they can no longer support the austerity measures required thus calling into question Portugal’s willingness to stay the Troika course.
2) WTI trading above $100/bbl for the first time since May of 2012 on the back of a significant drawdown in US inventories and the ongoing crisis in Egypt opening possibilities of a closure of the Suez Canal.
3) Further decline in the Eurozone economy as highlighted by the Services PMI data printing at a worse than expected 48.3 with almost universal individual national weakness.
4) Ongoing concerns in China on the PBoC’s ability to walk the line between preventing another housing bubble and supporting economic growth sufficiently to achieve 7.5% in 2013.
5) Comments from RBA Governor Stevens that leaving rates on hold was a close call indicating concern for further weakness in Australian GDP going forward.

It should be no surprise that this combination of events has led to weaker equity prices in both Asia and Europe with US futures also lower; modestly higher Treasury prices and a growing sense of anxiety around the world. The exception to this story is the UK, where the Services PMI was a much better than expected 56.9 helping the pound to rally nicely.

As I was posting my poems from 2010 on my website (www.fxpoetry.com) last night, I was reading some of the commentary I had written back then. Much of it sounded remarkably similar to current comments, except I marveled at Greek unemployment at 14% and Spanish at 10% wondering if the governments could withstand such clear failure. Obviously they couldn’t, as both those nations have elected new leadership since then, but also obviously, the new governments have not been able to stem the tide of woe. The real concern is that while the European periphery is the weakest link in the global chain, the problems they have are nearly universal amongst the developed nations around the world. Government has grown incessantly and its cost is starting to outweigh each nation’s ability to pay for it. The corresponding increase in national debt to unprecedented levels on a global basis is undermining any opportunity for a soft landing. The G3 central banks are printing money as fast as they can trying to support things, but no politician (or at least only a very few) are willing to discuss the fact that government promises made in the past were based on assumptions that did not pan out. This miscalculation has made those promises (Social Security and Medicare in the US, similar elsewhere) untenable, and private investors are searching for places other than government debt to park their funds. Today’s reaction was a 100bp rise in Portuguese 10yr yields, and spikes higher throughout the rest of Europe, Germany excepted. I still have a very hard time creating a long-term positive euro scenario.

Let’s look quickly at the emerging markets. Yesterday I reiterated my concern over BRL, which promptly fell more than 1% and seems poised for further decline. Two weeks ago USDBRL was a bit higher, but it seems to me that as long as Roussef cannot quell the protests, a move back toward the 2008 peak of 2.62 is quite possible. How about USDINR, which jumped back above 60 overnight to within 1% of its recent historic high. The news there is simply weak growth fomenting weak equities and no obvious way for either the government or the RBI to address the problems quickly. If we continue to see the overall global situation suffer, I think we could test 65.00 before the year is over. MXN has had a very nice retracement from its recent extended weakness to 13.46, but seems to be heading back in that direction. Again, it is hard to believe that with multiple concerns growing around the world over both economic growth and political stability that emerging market currencies will do anything but decline further.

Today we get a bunch of US data, starting with ADP Employment (exp 160K), and followed by the Trade Balance (-$40.1B), Initial Claims (345K) and ISM Non-Mfg (54.0). There is plenty to move things in this grouping, and quite frankly, I sense that further dollar strength is in the offing. Tomorrow both the MPC and the ECB meet, but no movement is expected by either, and of course, it is the July 4th holiday here in the US. Friday’s payroll data should be quite interesting, especially because US staffing will be light due to the holiday, resulting in less liquidity and more possible movement. Funnily enough, I think that the US data will print better than expected, and the dollar will benefit further as talk of the taper will resume.

Good luck
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