Morning Coffee Extra: Euro Commentary

As I said in an earlier post, the Gordian knot of interlinkages between macro indicators and markets keeps getting crazier....

                                                EUR-USD: Intraday (May 18, 2010)

                                  Source: BBC, May 18, 2010

The Euro is continuing its fall as the markets are not confident about the bailout and are even more worried about the fiscal conditions of Eurozone Govts. as mountains of debt pile up. Data from Bloomberg indicates that the euro slid below $1.22 after Germany said it will ban naked short-selling and naked credit-default swaps of euro-area sovereign debt and the Bank of Italy allowed lenders to exclude losses on government bonds.

A general drop in stocks and commodities spurred investors toward the safest assets.  

Rapid re-pricing of risk is occuring as the worries over the bailout gets replaced rapidly with worries about Europe's fiscal solvency and deflationary pressures. As the chart from the BBC shows, the euro fell as much as 1.9% to $1.2162, the lowest level since April 17, 2006. (Silver lining: European exports will get more competitive......but thats for later)

Naked Shortsells and Naked CDS banned: Further downside for the  €

Germany’s financial-services regulator has introduced a temporary ban on naked short-selling and naked credit-default swaps of euro-area government bonds. This has caused further pressure as markets reacted by further selling the Euro to indicate their discomfort with what is happening  (have a basic question: what kind of participants do we have anyway?)

A 'Naked' Primer from Bloomberg: When securities are sold naked, the trader fails to borrow the assets before sending an order to sell. Investors own naked credit-default swaps when they don’t hold the bonds the derivatives are linked to.

Hidden weaknesses? New Skeletons in the cupboard?

The Bank of Italy has permitted Italian banks to opt for new rules aiming at “neutralizing” the effect of capital losses and capital gains on regulatory capital from holding European government bonds. Hmmmm.......that step gives a lot of information out.....

It is possible that the Italian bank balance sheets remain weak and have no bandwidth for fresh losses......and that raises a more disturbing possibility....somewhere way down the line there may be some sort of debt restructuring......more negative feedback into the loop.....

While short-term interest rate support from the ECB has to be continued...the € will have to trade cheap to sustain interest whilst under such scrutiny....

Tailpiece: Is the UK watching?

Righto... next up: Oil......