More Euro Trouble

Greek Crisis May Provoke Fed-ECB Split as Euro Slides (Update1)

March 23 (Bloomberg) -- European Central Bank President Jean-Claude Trichet’s campaign for governments to learn the lessons of the Greek fiscal crisis may provoke a transatlantic policy split that forces the euro back toward its lows of 2006.

As investors push Greece, Spain, Portugal and Ireland to deliver on plans to cut budget deficits, the withdrawal of stimulus raises the risk of double-dip recession and even deflation in all or parts of the 16-nation euro area. The possibility of slower expansion is prompting economists from Deutsche Bank AG to HSBC Holdings Plc to predict Trichet’s ECB will be slower than they previously anticipated in raising its key interest rate from a record low of 1 percent.

Trichet’s restraint would contrast with Federal Reserve Chairman Ben S. Bernanke if the U.S. central banker takes the lead in tightening economic policy while lawmakers show few signs of attacking a budget gap of more than 10 percent of gross domestic product. Such different approaches across the world’s biggest economies has BlueGold Capital Management LLP predicting the euro will fall to $1.20 for the first time since March 2006, echoing a decline when the Fed last outpaced the ECB in the middle of the last decade.

“This policy divergence is one of the central pillars of my view going forward,” said Stephen Jen, managing director of hedge-fund manager BlueGold in London and a former chief currency strategist at Morgan Stanley. “It is one more reason for investors to be cautious about the euro.”

Contrasting Policies

Europe’s single currency fell 0.3 percent to $1.3515 at 8:50 a.m. in London today, taking its decline in the past four months to 10 percent, amid speculation European Union leaders will fail to agree on an aid package for Greece this week.

When the Fed last began raising interest rates, from 1 percent in June 2004, it overtook the ECB’s benchmark 2 percent by December and had increased the overnight lending rate between banks another seven times before the Frankfurt-based ECB first shifted its benchmark in the final month of 2005. That helped push the euro down 13 percent against the dollar in 2005, when it traded as low as $1.164 that November after three years of gains.

We’re shorting the euro,” said Stuart Thomson, a fund manager at Ignis Asset Management in Glasgow, which manages the equivalent of about $107 billion. “It’s impossible to see the ECB raising rates anytime soon in the current environment and certainly not before the Fed.”

Holding Pattern

Part of the reason for the ECB’s holding pattern is the growing likelihood of fiscal retrenchment. Governments have violated the EU’s deficit limit of 3 percent of gross domestic product for a third of the euro’s first decade. Now the turmoil in Greece is forcing them to consider greater fiscal discipline after investors more than doubled the risk premium they demand on Greek 10-year bonds over their German equivalents amid its struggles to cut a 12.7 percent budget gap, the most in the euro zone.

Greece has passed three packages of deficit-reduction measures this year, including cuts totaling 4.8 billion euros ($6.5 billion) announced March 3, in a bid to lop four percentage points off its budget gap this year. The spread between yields on 10-year Greek and German bonds jumped to as high as 396 basis points in January from as low as 132 basis points in November. The gap was 326 basis points today.


This latest news adds to our short term bearishness on the Euro and bullishness on the US dollar.
We remind our readers that a bullish US dollar tends to be bearish news for Crude Oil and Commodities.