LOOKING FOR SIGNS OF HOPE

THE Eurozone is in dire need of a quick capital injection, perhaps €2 trillion, says economist Nouriel Roubini. Roubini is not the only economist alarmed by the Eurozone’s banking system. Even outgoing ECB head Jean-Claude Trichet said recently that the systemic crisis must be decisively tackled, as the interconnectedness threatens the Eurozone’s financial stability, and has negative repercussions well beyond.

One criticism has been that even the enhanced European Financial Stability Facility (EFSF) won’t sufficiently accommodate potential large losses. There have been numerous proposals to shore it up – the most recent was that the EFSF would offer up to 40 per cent guarantees on sovereign bond losses, essentially insuring the fund. Insurance analysts say that such a plan could effectively leverage the resources of the EFSF to €2,900bn.

This year alone, the aggregate value of banking shares has been trimmed by 25 per cent, with Italian and French banks losing 37 and 33 per cent, respectively. Of significant concern are issues of bank funding. First, consider recent activity in the Eurozone’s sovereign bond markets; witness the ever-widening spreads between German bunds and Italian or French bonds. The second issue is funding duration – analysts point out that as funding terms are consistently shortened and banks roll over more debt each day, profit margins will be squeezed.

One thing is absolutely certain: policymakers must pack away the peashooters because the Eurozone needs what Prime Minister David Cameron calls a “financial bazooka,” and that’s exactly what markets expect.

SIGNS OF OPTIMISM
Current market sentiment suggests that investors feel they are reliving the nightmare of the 2008 credit crisis, with the same rising funding costs, the same stresses to the financial system and the same cravings for large-scale quantitative easing.

With the Federal Reserve’s activation of “Operation Twist” suggesting it is one step closer to renewing its “real” asset purchase program, and the Bank of England’s announcement of additional bond purchases of £75bn, it seems that the ECB is the missing link in the whole global stimulus scheme.

However, if the 2008 nightmare scenario is being repeated, then we are on the verge of a 10-15 per cent rally in European equities. Dependent of course on the ECB.

Another consideration is that more quantitative easing (QE) by the Fed and the ECB will signal, once and for all, that the foremost central banks are ready to create a bottom for the markets each and every time that they deteriorate. And when the bottom is clearly marked, markets will respond positively. The question is how long until the ECB agrees?

THE AVERAGE TRADER’S VIEW
When analysing the aggregation of traders among the eToro investment community, and comparing that data to their targets from a week earlier, it is evident that eTorians were quite accurate with their predictions in targeting a rather aggressive adjustment in the euro. However, now that the euro has reached its target of $1.374, traders have reversed course and turned bearish on the currency, with most activity concentrated on short euro-dollar exposure, with total net short exposure on the euro of 50,970 positions and a ratio of more than 3.5 times more short than long positions. The traders’ aggregated target for the pair is now $1.35, which is a rather moderate correction, and $1.4 is recognised as the pivot or weighted average stop loss.

From this analysis we have learned two important things. First, that eToro traders unanimously believe that the euro is exposed to a correction after rallying all the way from the $1.31 area. The second is that an upward break of $1.4 – a key, pivotal level for eToro traders – could melt mid-term selling pressure on the currencies and pave the way for a broader correction. Meanwhile, downward potential remains limited, above the bearish support level of $1.3 which the eToro community marked last week as their support level. Thus, $1.4 is the target to watch for.