It seems that overnight many traders were selling the EURO because of news that the Portuguese Government was to fall. As I have written about this before, it is certainly no surprise. The only surprise was its timing as it comes as the “RUBBER STAMP SUMMIT” is taking place today and tomorrow. Also, the credit rating agencies downgraded many Spanish Banks, making the EU SUMMIT that much more volatile. Throw in the French anger toward the Germans regarding its Libyan decision and the mood in Europe continues to darken.
These differences may be a mere sideshow if the Merkel Government was to suffer a crushing defeat in this Sunday’s election in Baden-Wurttemberg. If the CDU were to suffer an outright defeat, it would create a major problem for Chancellor Merkel and cause her to reassess many of her long-held positions. Merkel will certainly play politics. How do we know that? The decision not to aid NATO in the Libyan “no-fly” zone was meant to play to German voters who are opposed to German military actions. Many of the pacifist-oriented voters tend to be GREEN VOTERS and it is the GREENS who are gaining the most in the recent polls in BADEN-WURTTEMBERG. It also emphasizes why Merkel made the decision to shut down seven nuclear reactors, which is certainly the most contentious issue for the Green-leaning voters.
Again, we want to emphasize that Frau Merkel is a politician to the depths of her being and therefore it seems that if the German citizens were to tire of EU BAILOUTS OF THE PIIGS, well, you don’t have to be a WEATHERMAN TO KNOW WHICH WAY THE WIND WILL BLOW. This is why I believe that the Portuguese situation pales in importance to the German elections. Even with all this uncertainty in Europe the DOLLAR struggles to rally–WOW.
The British budget brought no surprises but it seems that a weak retail sales number today coupled with an MPC statement that was softer than the inflation hawks would have liked led to a selloff in the POUND–even against the beleaguered DOLLAR. The POUND had been the recipient of anti-inflation fever and the probability of higher rates. Again, the INFLATION HAWKS seem to have been disappointed.
Readers of NOTES FROM UNDERGROUND are well aware that I place a great significance upon the STEEPNESS or FLATNESS of the yield curves. The two steepest curves in the DEVELOPED world are the British and U.S. curves and they continue to be the weakest of the major currencies. The AUSSIE has the flattest curve. (Our readers should be aware of the 2/10s as they are a very good indicator of equity and currency movements.)
Steep curves are bullish equities and bearish currencies. Flat curves tend to be the opposite–of course, the trick is to time it effectively. Hour by hour, and day by day you may not see the impact, but if you do the analysis over a longer period of time you will be able to see the relationship. This is where we find ourselves at this time and as last week’s ferocious volatility showed, at the end of the day EASY MONEY WAS THE MAJOR DETERMINANT in a world saddled with several global macro uncertainties. Again, when the YIELD CURVE IN THE U.S. begins to FLATTEN in a significant way our macro view will change. As a corollary, if the GERMAN curve were to steepen because the ECB was not fulfilling its anti-inflation mandate, we would become negative on the EURO in relation to the DOLLAR.
I caution that this provides a much longer-term view and will not always play out in a trading world sometimes shaken by EVENT-DRIVEN HEADLINES. Trading short-term in a high-frequency, trading-dominated world will provide opportunities to those who see the bigger picture and are prepared to take advantage of the inefficiencies that can arise at any given minute or hour. Last week’s trading action was a classic example of this trading viewpoint. Tomorrow we will have a Canadian Parliamentary decision to shake us. It never ends.