EUR: What to Expect When Expectations Are Low

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The EU Leaders Summit is underway and at approximately 16:30 local time the President of the European Parliament will deliver a press conference that will be followed by a press conference from European Council President Van Rompuy at 22:00. There will also be national briefings to the press, which means its time to brace for headline risk. The European growth package is the only announcement that we expect today with other major decisions relegated to the press conferences on Friday. While weaker German unemployment and U.K. current account numbers weighed on the EUR/USD this morning, the broad based sell-off in risk tells us that investors are worried about a disappointment from the EU Summit. There is no question however that Europe will not get the solution that she needs to end the crisis from this meeting. The Germans have opposed shared debt liability ever step of the way and we would be lucky if they agree to a long term fiscal integration plan that is implemented well after German Chancellor Merkel’s term ends.

When expectations are low, investors are much more willing to accept disappointments. Very few EU Summits have resulted in major announcements and this one won’t be any different. If EU Leaders fail to convince the market that a fiscal union is in the works, the EUR/USD will sell-off but not by as much as some investors may expect. More specifically, the sell-off EUR/USD could be limited to its year to date low of 1.2288 if investors shift their hope to this next week’s ECB meeting. If the ECB fails to play the role of the white knight however and leave monetary policy completely unchanged, the EUR/USD will collapse more significantly as investors finally realize the gravity of the situation and the impossibility of recovery without an agreement from the Germans. In contrast, a compromise from the Germans and a credible blueprint for a fiscal union, even if it is long term could trigger a larger reaction in the euro. When expectations are as low as they are now, it doesn’t take much to surprise to the upside.

We know there will be at least 2 major announcements on Friday – a EUR130 billion growth package and a financial tax that would be used to pay for future bailouts. Both of these measures were agreed to at the four-way summit between German, French, Italian and Spanish leaders last week. While sovereign credit risk is important, supporting growth is also a critical step to turning Europe around because at the end of the day, the real problem in all of these countries is the high level of unemployment. Details on what the growth package will include should be shared along with the announcement of a Tobin tax, which is tax on financial transactions (sale of stocks, bonds and derivatives) that help to raise money for the governments and for future bailouts. There should also be plans to form a single European banking supervisor that oversees the region’s biggest banks. All these proposals are quick wins that can be implemented quickly without a change to the EU Treaty. Unfortunately none of these are the solutions that Europe really needs to end its debt crisis.

Meanwhile across the Atlantic, this morning’s U.S. economic data was mixed. First quarter GDP growth was confirmed at 1.9 percent but personal consumption was revised lower while prices were revised higher. Jobless claims dropped from an upward revised 392k to 386k. None of these reports will change the Fed’s bias to ease monetary policy.

Kathy Lien
Managing Director

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