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Liquid courage

2 February 2012 By Ian Campbell

It was supposed to be the year of the U.S. dollar. So, perhaps inevitably, the euro has opened the year well, rising from $1.27 in mid-January to $1.32 now. It has been supported by the flood of fresh European Central Bank liquidity, some encouraging reforms in Italy, the prospect of Greek debt reduction and the threat of a third round of money printing by a Federal Reserve still concerned about U.S. growth. But Europe’s fundamental economic problems remain unresolved – and are likely to drag the euro down before long.

Banks took up 489 billion euros in the European Central Bank’s new three year long-term refinancing operation in December. The abundance of cash has buoyed stock markets and helped bring sovereign bond yields down. The yield on Italy’s 10-year debt is now 5.7 percent, well down from the breathless Christmas peaks of over 7 percent. Sentiment also rose as Mario Monti, Italy’s caretaker prime minister, implemented some useful reforms, notably to pensions. Hopes that a Greek debt restructuring may soon go through is a positive, too. And the ECB will add to the pools of money buoying the euro and European stock markets with another LTRO in February.

It might appear that the wide-open central bank tap has solved the euro zone crisis. But declarations of victory are premature. Greece won’t be saved by a bit of debt reduction. Portugal’s yields have spiked as it, like other parts of the euro periphery and Italy, faces recession. That will hurt fiscal finances and points to a need for more assistance from other zone economies whose finances, with almost the sole exception of Germany, are weakening fast. A further risk is rating agency downgrades which may force banks to provide more collateral to the ECB to obtain financing.

Market signals remain ominous. According to the Commodity Futures Trading Commission, the U.S. regulatory agency, the net short position in the euro climbed to a fresh record high of $28.1 billion in the week ending Jan. 24. The net long position in the U.S. dollar rose to $20.1 billion. The bet will pay off handsomely if U.S. economic growth keeps the Fed away from more money printing.

But recession and periphery fears seem certain to burst the euro’s bubble. A fall back below $1.30 and run down towards $1.20 is probable in coming months.


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