Germany is the weak link in the Eurozone
ON FRIDAY, Europe’s bank stress tests are released. This comes at an interesting time for the single currency. Over the past month the euro has had an aggressive rebound, particularly against the dollar, and is now hovering close to the crucial $1.30 level.
Expectations are that it will stay around this level until the results are announced, says Michael Derks, strategist at FXPro: “If the stress tests are credible and don’t throw up too many casualties then this could be one of the triggers that sets off the euro breaking that $1.30 level.” At the end of London trading yesterday euro-dollar was at $1.2902.
Interestingly, not even new on Tuesday that Germany’s Hypo Real Estate bank is likely to have failed its stress test could push the euro lower this week.
But is this rally sustainable? Derks puts the euro’s bounce down to excessive short positions that had accumulated during the worst of the debt crisis. As you can see in the chart below, although investors remain net short the single currency, short positions against the dollar have fallen in recent weeks.
So if this spike in the euro is all down to positioning, how much further can the euro strengthen? Michael Hewson, currency analyst at CMC Markets, says that the next price objective is $1.3125. Hewson adds that, dependent on how investors’ take the news, a bad result could see the euro tumble towards the $1.2750/60 area.
In the longer term, there are still plenty of reasons to be bearish on the single currency. Schroders’ chief investment officer Alan Brown entered the fray this week when he said that Germany will break the euro: “There is a ghastly inevitability to what is happening. The inevitability comes quite simply from the maths and German insistence on austerity everywhere coupled with its unwillingness to contemplate stimulating its own economy.”
The maths that Brown is referring to is the austerity measures Germany is prescribing to Greece: that all Eurozone members must cut their budget deficits to below 3 per cent of GDP. If Greece does all that is required of it, then Brown calculates it will have a debt-to-GDP ratio of more than 150 per cent in the coming years, and will have to run a primary surplus of 8 per cent of GDP to stabilise its debt ratio. In this instance, “restructuring (or default by any other name) coupled with withdrawal from the euro would be the lesser of two evils,” he adds.
Brown’s answer is for Germany to stimulate its domestic demand, or for the “rich” Eurozone countries, led by France and Germany, to leave the euro. Either way, the stress tests are not the final chapter in this euro horror story.