The Monday Report

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By Greg Peel

I suggested last week the euro was now in a lose-lose situation or, if you like, damned if they do and damned if they don't. If the leaders of the eurozone fail to deploy the emergency currency protection fund and the ECB is unable to sterilise groaning PIIG debt obligations then the euro is destined to collapse – not just in value but in structure. The announcement of the E720bn fund is one thing but outside the IMF's contribution, the member parliaments still have to approve a fund which is three times larger than the Greek rescue fund which is itself three times larger than Greek Plan A.

Yet if the fund is approved and deployed and the euro is saved as a common currency concept then what are we left with? The weaker economies in the eurozone will be long hampered by deflationary austerity measures while the stronger economies will be hampered by having to redeploy export receipts to cover the debt obligations of the weak. And the ECB will have to print ever more euros. While the one saving grace will be more competitive prices for eurozone exports (Germany is the world's biggest exporter) the eurozone economy will continue to contract or at least fail to grow with any meaning for quite some time.

It would seem an obvious solution for the stronger economies (and polls show a preference from their electorates) to simply withdraw from the eurozone, leave the PIIGs to their own self-inflicted fates and let the IMF handle the problems individually given that's what it's there for. Germany, for example, could return to a strong Deutschmark built on an individual trade surplus and high level of domestic savings.

The only problem is that any withdrawal from a senior member of the eurozone would inevitably result in the end of the euro anyway, which brings us back to the “damned if you don't” scenario. Across the EU, which includes the likes of the UK, Sweden and Norway, banks and corporations are all intertwined via euro-denominated loans. How does one revalue the debit/credit ledger without mayhem? And obligations are not simply contained within Europe.

Moreover, if it fell to the IMF as sole rescuer of all the PIIGs and others – which would no doubt mean depression conditions for those previously reliant on the support of the common currency – then every IMF contributor is in the frame, and the US contribution is 17%. The requirement to bring in the IMF now is already an effective tap into the world's largest, and most indebted, economy.

And let's not forget that the success of a euro rescue is also reliant on quelling the civil unrest which at this stage is contained to Greece but could well spread further. Even if the Greek government were overthrown and a new government elected on eurozone withdrawal, the fact that Greece is one of the smallest economies in the zone would not prevent the same web-of-euro-debt calamity across the continent.

It is with this assessment in mind that one can now turn to the reason the euro was again heavily sold on Friday night – down another 1.5 odd cents to US$1.2358 – and global equity markets and commodity markets followed suit. A rumour spread of a report which suggested French prime minister Nicholas Sarkozy, frustrated at initial resistance of eurozone members to quickly establish a rescue plan for Greece earlier this year (at that stage the E20bn of Plan A), threatened to withdraw from the eurozone. Obviously a reluctant Germany was the target of his frustration.

The rumour has since be denied of course, but if true, even if it were simply a hollow threat, the fact remains global market confidence at this point is reliant on a united Europe. Leaders have publicly declared unity, and declared a determination to “save the euro at any cost”, but there is little doubt in any observer's mind that there has been an awful lot of heated bickering among age-old enemies going on in the background. And at every step the EU finance ministers have been at odds with eurozone's central banker, the out-of-touch Jean-Claude Trichet.

There is now talk that Trichet's days are numbered.

The Dow fell 162 points or 1.5% on Friday while the S&P fell 1.9% to 1135. Major European stock indices fell 3-5%. The VIX jumped 17% to 31.

It was another round of flight to quality which saw money rapidly exit stocks and speculative commodity positions (aluminium and copper down 4%, nickel and zinc 5%, lead 7%, and oil down 4% or US$2.79 to US$71.61/bbl), reverse yen carry trades, and buy US dollars (dollar index up 1% to 86.26) and US Treasuries (ten-year yield down 8 basis points to 3.44%).

It also meant exiting commodity economies (Aussie down one cent to US$0.8858, SPI Overnight down 79 points or 1.7%).

This time, however, gold did not benefit. As I noted last week, having enjoyed a mad rush from panicked investors for a couple of weeks gold will likely now need to consolidate around the US$1230/oz mark, being the level of its previous record high. On Friday gold fell US$1.20 to US$1231.40/oz.

Beneath the global anxiety, the US economy continues to show solid signs of improvement. April retail sales rose 0.4% compared to 0.2% expectation. April industrial production rose a better than expected 0.8%. The fortnightly Michigan Uni consumer confidence index rose to 73.3 from 72.2 one month ago, albeit slightly less than expected.

But US economic recovery relies on expanding US exports. Late last year it was clear the US government was happy to let the dollar depreciate and thus support export competitiveness, and at 75 on the dollar index the plan was on track. But with the euro's collapse the index is at 86 and the plan is off track. How long before the situation across the Atlantic begins to impact on US economic data? Stock markets are expressing that fear.

There is a wealth of US economic releases this week, beginning with the Empire State (NY) manufacturing index, NAHB housing sentiment index and Treasury long term capital flows on Monday. Tuesday brings housing starts and the producer price index. Wednesday sees the consumer price index and the minutes of the last Fed meeting while on Thursday it's the Conference Board leading economic indicators and the Philadelphia manufacturing index.

With Europe in the frame there will be interest in eurozone business and consumer confidence surveys this week, along with CPI, trade balance and current account, and Germany reports its first quarter GDP on Friday. But most importantly, on Wednesday night Greece has to roll over E18.5bn of sovereign debt. It is this upcoming refinancing requirement that has hastened the EU's resolve to approve the E110bn Greek rescue package. How much will be needed?

Japan will report its first quarter GDP on Thursday.

It's a quieter week in Australia, beginning with first quarter housing affordability and the minutes of the last RBA meeting on Tuesday. Economists will be sifting through the document for confirmation the RBA now intends to hold rates steady for at least a few months. Wednesday is Westpac's measure of consumer confidence along with the first quarter wage cost index – something the RBA will be very interested in. We end with consumer inflation expectations on Thursday.

On the local stock front, Myer ((MYR)) will report quarterly sales numbers on Monday and AWB ((AWB)) will report interim earnings on Wednesday.

For further global economic release dates and local company events please refer to the FNArena Calendar.

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