It's time for a shirt: "Irish bondholders got a bailout and all the EURUSD managed was a measly 35 pips higher." It seems the currency vigilantes are calling the bluff in JC Trichet, and tomorrow Portuguese bonds will be next on the bidless brigade, further validating that the IMF's, just like the Fed's, primary mandate is to rescue insolvent bankers everywhere there is a taxpayer population that can be raped. But back to the EUR: at last check the currency was trading well inside 1.33, and only about 2.2k pips from Thomas Stolper's 12 month target of 1.55. Not to begrudge anything to Tom: after all, post QE4 he will certainly be spot on (the only question is how long it take Blackhawk Ben to get us there), but we wonder if another Goldman luminary got the memo. To wit: in an interview with the Telegraph, Jim "BRIC" O'Neill told Kamal Ahmad that "the eurozone must embark on a significant round of fiscal and political harmonisation if the euro is to survive...there are elements of the black swan concept that seem rather applicable to the EMU story" and if that wasn't clear enough, he added that the "euro should carry a "risk premium" and that it was over-valued by at least 10pc." Bottom line, according to O'Neill the "fair value for the euro is €1.20 against the dollar and anyone buying it 10pc above that is not very sensible." Uh.... What? Did Wikileaks intercept the memo from Thomas Stolper sent out just this November 25, in which the chief currency strategist said: "Overall, we believe the EUR/$ remains very much on track for the projected trajectory of 1.40 in 3mths as well as 1.50 and 1.55 in 6 and 12 months." And like that, Goldman has all bases covered. Of course, seeing how the outcome is binary, Goldman has just discovered the Schrodinger currency: per the bank that rules the world, the euro is now both alive and dead at the same time.
As a reminder, here is what Stolper said 3 days ago:
The primary market focus currently is on Eurozone sovereign risks again. Our baseline is that these risks will not escalate much further. Specifically we believe that Spain will not need a bail-out as Francesco Garzarelli and Erik Nielsen have continued to highlight. Should this assumption turn out to be right, the EUR will likely strengthen again, otherwise we could see another sustained broad decline. In any case the current drop in EUR was not really a surprise. For example we highlighted since the summer in our FX research that the implementation phase of European fiscal tightening and further reforms will likely lead to renewed tensions and pressures on the Euro. Though to be fair, we initially thought this would materialise earlier.
At the latest forecast revisions in early October, we explicitly mentioned the risk of a temporary dip below 1.30 in EUR/$ on European sovereign issues and broader risk aversion. However, our baseline is that sovereign stress abates fairly quickly as otherwise our view of a relatively quick move back up may not materialise. And these fiscal worries are a powerful force, which even managed to temporarily overcome the risk correlations as we could see at the beginning of 2010, when stocks did well globally, the correlations in daily returns remained unchanged but where the sovereign concerns in Europe led to a strong temporary EUR down trend nevertheless.
A related risk is that fiscal tightening leads to much weaker growth performance in the Eurozone, but there again Germany acts as an anchor. With very little fiscal consolidation needed the overall fiscal tightening in the Eurozone will be far less than in the peripheral countries.
On the positive side, the latest round of PMIs suggests the core of the Eurozone may continue to show upside surprises, which over time would likely help alleviate sovereign stress and support the case for tighter ECB policy.
Overall, we believe EUR/$ remains very much on track for the projected trajectory of 1.40 in 3mths as well as 1.50 and 1.55 in 6 and 12 months. Of course, the biggest near term risk is further deepening of the Eurozone sovereign crisis and there is no doubt that further EUR/$ weakness would be the result. On the other hand, if things calm down again, opportunities for tactical long positions look increasingly good.
Finally, one question we face very often is about the viability of Eurozone growth with EUR/$ at 1.55. Our answer is that we really believe in broad USD weakness and hence the trade weighted appreciation of the EUR will be fairly limited if our forecasts are correct.
And some more:
Our EUR/$ Baseline Forecast
Sometimes we find it useful to look at an ideal USD downside scenario before comparing our forecasts with this benchmark. This approach helps looking beyond all the short term factors dominating the headlines and to cut out some market noise.
Starting with continued strong correlations to risky assets, it is pretty clear that the USD tends to weaken when risky assets perform well and vice versa. This in turn suggests that USD weakness requires a clearly positive outlook for cyclical assets. One of the reasons why this correlations still holds in our view is that a large number of foreign investors in US equities are currency hedged, whereas US investors in foreign stocks rather tend to be unhedged. As a result a global risky asset rally tends to translate into asymmetric flows from foreign investors who end up being under hedged and need to sell more USD against their home currency. A positive global decoupling scenario with persistent US imbalances is pretty close to such a weak USD scenario from a risk correlation point of view.
The hedging asymmetries also suggest that a scenario where the US is clearly in the process of adjusting the structural imbalances would ultimately be USD positive as equity investors may start reducing their hedging asymmetries. This in turn would lead to sizable USD buying.
Finally, looking at the policy mix, tighter fiscal and easier monetary policy in the US than in most other countries would also help reduce support for the USD.
Our current macro forecasts pretty much tick all the boxes. We expect a continued global recovery with still persistent imbalances in the US and easier monetary policy by the Fed than in most other places. On the basis of this global view USD weakness remains the most likely trend to dominate FX markets. As part of a trade weighted Dollar decline we would certainly expect the Euro to join in. And in fact, many of the macro factors in the US seem to be the other way round in the Eurozone, including tighter monetary policy and a positive risk correlation for the currency.
So how come Jim O'Neill can hit the press circuit less than 48 hours later and say that the Euro is virtually doomed:
"There are elements of the black swan concept that seem rather applicable to the EMU story," Mr O'Neill said.
"You have to consider that very extreme outcomes could be possible. I'm generally a person that sees the glass half full, but there are aspects to this European situation that could involve some pretty ugly developments.
Is there a power struggle within Goldman? That is the only one to explain such a dramatic divergence in opinions on the future of the common European currency:
"The euro deserves a risk premium - it is expensive compared to fair value. I think fair value for the euro is €1.20 against the dollar and anyone buying it 10pc above that is not very sensible.
"[The question is] how can you have a monetary union with such disparate countries without having some form of fiscal union? It's a pretty good question. I think the evidence is growing that you actually can't."
Asked directly whether, looking over a five to 10- year horizon, he agrees with the argument that there will either be a break-up of the single currency or a fiscal union, he said:
"I think that is right. We won't get an answer for many years and we will waver between them both but you will get greater evidence of [fiscal union]. People talk about a European monetary fund which effectively would have the ability to approve a budget plan before it was put to a country's voters."
Of course, it wouldn't be Jim O'Neill if he didn't infuse half a metric ton of his own personal unfounded hopium in the mssage:
He said that he expected to see a pick-up in the US economy and that the dollar could therefore strengthen. That would then would then exert downward pressure on the value of gold.
Odd. We on the other hand anticipate that the complete collapse of the sovereign debt house of cards may actually result in upward pressure in the price of gold.
But who are we to say anything: after all our opinions are, gasp, consistent, with what we say at least two days earlier.
Full O'Neill clip.