EUR Firepower Expansion to Backfire

A combination of factors is working against the reserve currency of choice first thing this morning. The mighty dollar is attempting to flee March under pressure on month and quarter-end rebalancing flows combined with expectations the US monetary policy will stay soft for longer than previously thought. Both equities and the EUR have gained on expectations the Euro region’s finance ministers will agree in Copenhagen to increase rescue funds at their two-day meeting starting today.

The market is rolling the dice and betting on euro-zone finance ministers to approve combining the regions two bailout funds. It’s an intermediate scenario, in which unused capacity in the EFSF would remain available for new lending along side the ESM until next year. Perhaps an “official” announcement of an increased firewall may help reduce some market volatility as doubts begin to creep in over Spain, Italy and bailed-out Portugal. Rationally, any talk of need to increase funds only leads to new speculation and uncertainty. Do not expect Germany to throw its full weigh behind this, vocally they seek structural change as a priority.

Spain, a country on a one day general strike yesterday, will deliver its budget plans this morning. The labor reforms being pushed through should attempt to reduce the high unemployment and help with growth. However, there is a fine line in how much austerity measures can be implemented, too much and all bets are off. Periphery countries like Ireland are already on that cusp.

If we exclude month and quarter end balancing requirements, which tend to be a prerequisite portfolio balancing charade not influenced by most macro fundamentals, then todays risks from economic news flows have shifted to the downside. A scenario that does not warrant supporting the single currency outright wholeheartedly. Forward looking and China remains the source of capital markets greatest disappointment. Already the flash estimate of the HSBC China manufacturing PMI suggests that the official PMI, out on Sunday, will likely fall in March. However, if the PMI manages to hold above 50, it could provide some relief for Asian currencies and the floundering Aussie heading into rate announcement.

Are markets pricing in too much risk appetite with beefed up regional bailout funds? We are witnessing Italian and Spanish yields falling, proving risk is being applied. Buy the rumor, sell the fact, a classic FX play is on. Allowing the EFSF and ESM to run parallel will not be the reason for a change in trend reversal of the EUR. Even if the bailout fund capacity reaches +EUR1t with IMF help (for optic reasons), expect any positive effect to wear off quickly as we head into a tough week next week littered with global PMI’s.

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EUR to Buckle on Month End?