Kicking the Eurozone can down the autobahn

YESTERDAY saw more volatility in the markets – triggered by a mixture of the weekend’s announcements and by bargain-hunters going shopping in the equity markets hoping to snap up stocks that they saw as being oversold.

At the weekend, Christine Lagarde led an IMF summit, warning that the $384bn (£248bn) earmarked as an emergency bail-out fund is not sufficient support for the Eurozone’s troubled periphery nations.

This summit came hot on the tail of suggestions that European policymakers were planning to boost the European Financial Stability Facility (EFSF), by increasing the capital available from €440bn to €780bn and leveraging this capital to as much as €3 trillion. But the chances of an increase in funding for the European bailout fund hangs upon the outcome of the EFSF expansion ratification vote to be held in Germany on Thursday – a vote which could have a big impact on European and world markets.

An early sign of the volatility expected in the markets in the coming weeks was summed up by an announcement made by the CBOE Futures Exchange. It announced that the futures contract opening time for the the CBOE Volatility Index (Vix), often dubbed the “Fear Index” would be moving from 7:20 am to 7 am, pending regulatory approval. It announced that: “The earlier opening offers market participants more time to establish or offset Vix futures positions surrounding potential market-moving events – overnight news, banking actions or key economic reports – before the general market opens.”

This weekend’s summit in Washington produced little more than a lot of empty rhetoric, leaving the Greeks still teetering on the very edge of default – with just such an outcome now looking increasingly likely. Thursday sees the German vote over the latest changes to the EFSF and although this will probably manage to claw its way through, the growing ranks of Germans utterly disillusioned with more of their funds being thrown into a seemingly bottomless pit in Athens suggests again that this route can’t have that much longer left to run. Add to that the fact we’ve got the risk of another sovereign downgrade hitting one of those “too big to fail” nations like Spain or Italy and we have another trigger that could serve to reignite the crisis. Will Greece receive its next tranche of bailout funds? With the Troika still to get back on the ground, safe havens like the greenback, US Treasuries and German Bunds will all remain popular since any resurgence in risk appetite is likely to be temporary at best. Eurozone politicians may have given themselves six weeks to resolve the crisis, but markets may not wait that long.

When things are really starting to get into a worrying state, little warning signs emerge. The first is that risk assets take a big hit and the second is that safe havens see an influx of capital. Some of the riskier assets like commodities and equities have seen substantial corrections in recent weeks and only yesterday gold saw a mass sell off. It may traditionally be considered a safe haven but it is susceptible to sharp sell offs just as any other asset is.

The ultimate safe haven is the US dollar, which has appreciated some 7 per cent in the past few weeks alone and this is the other alarm bell. Similar moves happened in the run up to and after Lehman Brothers, so investors should beware of another possible collapse in the markets.

The problem with the European situation is that politicians are shutting the stable door well and truly after the horse has bolted. Confidence is shot to pieces, inflation is still ravaging real incomes – both of which are things that are not conducive to a growing global economy. The future is bleak I’m afraid, even if political leaders have just woken up to the gravity of the situation.

I see the political wrangling and time-wasting continuing, and this lack of urgency to take harsh, but ultimately essential decisions is a real worry. The longer this persists, the more confidence can leak from the key but undercapitalised European banking sector, and thus the region itself. With bank shares having taken a real savaging, how much more can the sector take? A gloomy economic outlook doesn’t help. In the case of a double-dip, Germany’s reputation as the region’s backbone would be of little help.

While fears remain, the euro could fall back to $1.29 against the dollar. Preference for the greenback, combined with lower industrial demand, would also likely continue to weigh on commodities, including the safe-haven metals.

Contagion is the fear, but the powers that be seem unconcerned by their own pedestrian pace of progress. On the flip side, this slow pace has meant increased speculation and heightened volatility, both of which appeal to short-term traders. I see Greece getting its next tranche of aid. However, without any real progress elsewhere, we’ll likely be discussing direction again come the middle of next quarter. Actions speak louder than words.

Traders returned to their screens Sunday night to find the euro rally initially hit resistance around the $1.355 area. Almost as soon as the Asian markets opened in earnest though, it was downhill all the way to lows of $1.336, as traders once again fretted about the perilous state of the Eurozone.

The reports coming from the meetings of the IMF in Washington over the weekend suggested the US and other major nations pressed European leaders to increase the effective size of their €440bn rescue fund to perhaps trillions of euros by borrowing against it. Germany is reluctant to add any more funding to the EFSF, so this attempt to leverage the fund in an attempt to ward off a deeper crisis in Europe seems to be the latest attempt at a solution.

Some are saying an orderly default for Greece is inevitable. It looks like traders are treating these plans with a degree of cynicism until a full plan is delivered, and the euro remains under pressure. $1.340 is an important line in the sand in euro-dollar. But should the situation worsen for Greece – or indeed if the dollar rally continues – then we could see euro-dollar plunge as far as $1.300 – the lows of last November and January – before long.