Spain Down Euro Up
With Spain on the brink of collapse and poor investor appetite for Italy’s bonds, a May Day rally moved the euro and the Swiss franc to one-month highs against the USD. The euro climbed by 0.2 percent settling at $1.3274. The dollar gave back 0.2 percent to the Swiss franc closing at 0.90500 francs. Given the instability in the euro zone, the currency has not fallen below the $1.30 mark since December 20th.
The April fall of the euro by 0.8 percent seems more realistic. The currency finished April with its worst monthly performance since December 2011. The rise of the euro is based on unsettling economic developments in the US. Data released on Monday lent to concerns about the strength and depth of the US recovery. Poor consumer sentiment and disappointing manufacturing data from the Midwest caused a lowering of GDP projections to 2.2 percent.
Both the euro and the dollar fell against the yen. The euro hit 2-weeks lows against the yen as the US fell to 2-month lows at 79.10. In anticipation to Tuesday’s meeting of the Reserve Bank of Australia, the AUD fell 5 percent to $1.0418 USD.
In the US, equity markets look for relief from the Federal Reserve, but several of the Fed Governor’s have been vocal in dissent of a possible QE3 stimulus package. The demand for US exports has been diminished by the crisis in Europe, the USA’s largest importer.
Spain Fighting The Inevitable
Last week, S&P lowered Spain’s credit rating to BBB+, regarded as generous by many investors. On Monday, the axe fell for 9 of the country’s 10 largest banks that were lowered to junk rating. Spain has pushed for consolidation of the country’s banks. The result of this has put undue pressure on the 10 banks.
The country’s banks have taken on large pools of distressed and defaulted assets and are finding dwindling deposits and skeptical investors. The country’s banks are the largest holder’s of sovereign debt.
Greece was spared because the region’s two largest economies, France and Germany, were heavily vested in the struggling economy. Spain does not have that luxury. The only elements that can help Spain are the continuation of the ECB to purchase Spain’s debt. Technically, Spain does not meet the IMF’s stringent requirements. Spain’s Prime Minister and his cabinet remain steadfast that Spain does not need outside support.
Without a rescue plan, the question is no longer will Spain default but rather when will Spain default. The populace wants change and a loosening of the austerity programs that are shrinking GDP.
A Monday report regarding Spain’s 24.4 percent unemployment rate eerily resembles US unemployment during the Great Depression in the 1930’s. A study of the US unemployment rate in the 30’s suggests that Spain has not seen the worst. Since July 2007, Spain’s unemployment rate has been a vertical climb without any plateaus of relief.
There appears no relief for Spain. Unlike Greece, Spain’s default could easily be unstructured. This event may trigger a domino effect for nations like Portugal, Ireland and Italy. The European Stability Mechanism (ESM) is underfunded to meet these cumulative needs.
Spain’s ten-year bonds are yielding 6 percent, an unsustainable rate. While the country has implemented austerity cuts, they appear too little, too late.
France And Greece
Two key elections this week may shape the trajectory of the euro zone. Incumbent French President Nicolas Sarkozy is a distinct underdog to keep his job. Socialist Francois Hollande is the favorite and has run on a platform calling for reform in the euro zone treaty.
In Greece, the outcome to the elections is not clear. However, there are undertones that Greece will not comply with its bailout agreement deemed unacceptable by the citizenry.
What has been increasingly apparent is that austerity cuts alone do not work. The better formula for growth involves well-considered cuts and support by the ECB and IMF. These loans are not quantitative easing, which would be the best way to proceed. However, the ECB funds are low interest and fairly loose terms.
Austerity cuts only address one side of the problem. Economists advocate a balanced approach that can lead to growth, the most important component in a recovery. The euro zone’s paymaster does not see it that way. Germans have difficulty funding poorly administered economies.
No matter how you slice the pie, euro zone’s recovery must have a path for growth. If Spain, or any other euro zone nation, were as focused on growth as they are on austerity, the economy would have broader appeal to investors. There is no way standalone austerity cuts can accomplish the job.