MORGAN STANLEY LEGGE MERCATO LIBERO?
While the EU Summit has been seen as a success on many levels and may well be viewed as going some way towards starting to address structural problems in the Eurozone, the immediate problems are far from solved.
As a result, any EUR relief gains are expected to remain limited in our view. Indeed, some EU officials clearly do not believe that the agreement goes far enough. The EU’s Junker has commented that the measures are insufficient and that further steps will have to be taken at the next Summit in March, highlighting the lack of centralised economic authority.
We maintain our bearish EUR view, and have in fact lowered our EURUSD forecast for 2012 to 1.15, from 1.20 previously.
While perceived progress will likely provide support to peripheral bond markets and Europe asset markets, we still believe it will be a mistake to translate such developments into a bullish EUR view.
It is worth noting that peripheral bond spreads have stabilised and CDS spreads have also adjusted lower in many cases, resulting in a significant shift higher in our measure of risk adjusted yields, which has historically been associated with a rebound in EURUD. The fact that the EUR has not been able to take advantage of the more supportive environment, as highlighted by the rise in risk adjusted yields, is further evidence supporting our view that the fundamental picture for the EUR remains weak.
Needless to say, a collapse in the EURUSD will evoke an inevitable and violent response by the Fed, something we noted before, and something which MS also, wink wink, has realized:
...analyzing the impacts of QE1 and QE2 we made two observations. First, the market impact of QE2 was significantly smaller than that of QE1 and second, QE2 developed a front loaded impact. We think markets have started pricing in QE3, suggesting upside potential following the formal announcement of QE 3 will be limited. Once QE3 begins, it may be time to implement currency trades that benefit from risk aversion.
It is our view, that once the EUR implodes, the Fed will have no choice but to intervene yet again, thereby sending the USD plunging and the EURUSD back to 1.50 or so, but everything in its course.
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