But for the moment, a new optimism about the eurozone is in the air

Foreign Exchange - Pounds Sterling and Euro Exchange Rate Outlook

The US dollar exchange rate is correcting downward after a big move up earlier this week, in part as a purely technical response to an overbought condition and in part because German Finance Minister Steinbrueck announced yesterday that Germany may be stepping up to the plate to offer "emergency" financial aid and leadership to the rest of the eurozone countries. What form this might take is unclear but Chancellor Merkel is holding a press conference later today (4:15 GMT) with EC Pres Barroso, so we might get details.

From the midday low in New York yesterday at 1.2510, the euro has swooped up to 1.2723 or over 200 points in less than 24 hours.

A German initiative could be a watershed moment, since the ECB lacks the authority to and operating capability to assist on the fiscal front. The eurozone lacks institutional depth - it has no combined Treasury/Ministry of Finance, let alone a State Dept and the other functions of a political union. The eurozone is little more than a customs union with a common currency. To address this shortcoming is a major step forward.

The announcement may bode well for the future of the euro but perhaps a little less well for the idea that the eurozone is a band of equals. By Germany taking a leadership role again, as at the beginning of the customs union, it is again clear who has the most self-interest at stake in the survival of the euro. To be fair, Germany has already sacrificed much for the sake of the eurozone, chiefly in the form of the cost of reunification of East and West, and it looks like it will be doing it again. This is both pragmatic and idealistic at the same time. Since Germany was willing to spend only €480 billion in stimulus funds last fall, the willingness to take on massive new debt is also a sea-change - if that is what is happening.

Or are our imaginations running away with us? If the German "leadership" turns out to be weak, insufficient, or not accepted by the others, the euro exchange rate could be punished. We are also skeptical of a comment reported by Bloomberg from an analyst in Singapore that "The markets may begin to perceive that the U.S. economy will fare worse than those of other major countries. This is likely to be negative for the US dollar." We don’t buy it at all. The US economy is bigger, more robust and more adaptive than any other. That doesn't mean it makes the right policy choices or that it is destined to succeed - the probability of failure is not zero - but the idea that it will fare worse than other countries, even mighty Germany, is improbable.

But for the moment, a new optimism about the eurozone is in the air. The euro exchange rate correction has already gone to the limit of the usual correction after recognition of an oversold level, about halfway up the breakout bar. If the euro rate breaks the linreg channel of the current move at about 1.2950, the whole ball game could change.

A dose of skepticism is proper. Today the Bundesbank in the monthly report renewed its usual statements that the German government must promise to reduce deficits once the crisis is over to maintain investor confidence. Pump-priming is fine but will take time to get a grip, and in the meanwhile, a plan to reduce deficits has to be made and believed. "Past experience has shown that it is easier to reach a consensus on expanding deficit spending than on the necessary consolidation of public finances afterwards. After all, confidence in the long-term sustainability of public finances is a condition for the success of government stimulus measures."

So how would a German rescue plan line up with the BBK's strict ideas about keeping to the Stability Pact, since Germany is already at the 3% cap? Clearly if Germany is going to buy the paper of distressed countries (Portugal, Italy, Ireland, Greece, Spain), it will have to get a waiver from the EC and the ECB. This is kind of like a hall pass… and doesn't address the source of the most recent crisis, Eastern Europe. It’s unthinkable that Germany would rescue Hungary, Poland, the Czech Republic and other non-members-isn’t it?

In other Foreign Exchange market news, Barclays says the Canadian Dollar is about to change direction (and recommends traders to sell the US dollar in a 9-month timeframe). Risk aversion could take the Canadian Dollar to 1.30, but that’s about it. "We see the Canadian dollar emerging with a cyclical growth profile that is as good as or better than that of the U.S. dollar, with far fewer structural and policy negatives." The Bank of Canada will start raising rates ahead of the Fed, and Canada will spend less on stimulus, too. We say it’s ridiculous to imagine that the Canadian economy can fare well when the US economy contracts. Canada is joined at the hip to the US.

Pounds to US Dollars = 1.4338
Pounds to Euros = 1.1270
Euro to Pounds = 0.8868
Pounds to Australian Dollars = 2.2100

Bye For Now

Barbara Rockefeller
Foreign Exchange Trading
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