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Analyst Interview: Christopher Vecchio on European Optimism, US Debt

Analyst Interview: Christopher Vecchio on European Optimism, US Debt

Christopher Vecchio, CFA, Senior Strategist

Various European officials expressed their belief that this year the debt crisis in the area should wane gradually. To you agree that 2013 is going to be a brighter year for the Euro-zone economy?

I think that this is the calm before the storm. The ECB’s OMT program announced in September (first rumored in July, when President Draghi said that he would do “whatever it takes” to save the Euro) has served as a very formidable safety net – one needs to look no further than Italian and Spanish 2-year bond yields, which have plummeted over the past several months. But there are a few very important lingering questions: will a Mario Monti-endorsed government retain power after the Italian elections in February; how will Spain keep its yields low once it stops looting public pension funds; is France becoming a periphery country; will Alexis Tsipras finally wrangle control of the Greek government and leave the Euro-zone; and if Germany remains opposed to lower interest rates, how will the ECB stoke growth in the region? The region remains a ticking bomb, and if liquidity is the best solution offered, a rude awakening could be around the corner.

Has the consistent drop in Spanish borrowing costs effectively removed the specter of a bailout request for the country?

Yes, but only for the time being. At the end of the day, it’s important to remember that Spanish Prime Minister Mariano Rajoy is still a politician vying for votes, tending to his electorate. Taking an international bailout would essentially be him waving the white flag: ‘we have lost control, we need help.’ That would not be a strong platform for retaining power. PM Rajoy has and will continue to stave off a bailout for as long as possible – but if Spanish yields rise in the middle of the year, I would expect a bailout to be on the table without question.

What consequences might delaying the debt ceiling decision have for the US?

Nothing. As we’ve already seen, global market participants have called US politicians’ bluff. The process is as follows: rhetoric from both Democrats and Republicans about wanting to find a solution together; political grandstanding to show voters that they are remaining true to their belief systems; and finally an eleventh hour compromise that narrowly misses a default. But in the true Keynesian sense of things, markets have shifted their mindset from ‘the US deficit is bad’ to ‘aggregate demand is low enough that running a deficit to support growth is necessary.’ In fact, because US growth is so fragile right now, the massive sequesters that are due to be triggered should the debt limit be breached would undoubtedly take -1.0% to -2.0% off the headline GDP figure this year. This is a, ‘out of sight, out of mind,’ scenario: delaying the debt ceiling decision just removes another potential hurdle down the road.

The Euro broke up the 1.3300 level to reach levels not seen since Feb 2012. Do you see the Euro climbing above the 1.3500 in the short term? Any possibility for the 1.40?

The EURUSD has some upside momentum left in it, but what’s important to consider is the potential impact of what the Federal Reserve is signaling – that they prefer to finish their open-ended bond-buying later this year, putting monetary policy on path towards normalization by the time Ben Bernanke finishes his tenure as the Fed Chairman. Rejection today at 1.3400 for the fourth time this week signals two potential interpretations of price action from here: a Bull Flag is forming, pointing towards 1.3480/500 and 1.3555/90 as potential near-term targets; or a Double Top has formed, suggesting a pullback towards 1.3135/65, and 1.3000/30 lower. It’s worth noting that the daily RSI downtrend that took place at the beginning of the year has broken to the upside this week, suggesting that the pair remains a dip on buys.

The USD/JPY jumped to trade above the 89.50 lately, levels not seen since 2010. Do you expect more appreciations in the months to come? What is your forecast for the USD/JPY?

The USDJPY looks like it could move as high as 110.00 this year, although I do expect a significant retracement in the coming weeks. With respect to the near-term pullback, the mindset for the Yen is the same as it was for the US Dollar leading up to the Fed’s QE3 announcement in mid-September: buy the rumor, sell the news. Indeed, the Dow Jones FXCM Dollar Index (Ticker: USDOLLAR) bottomed the day after QE3 was announced; and a similar outcome wouldn’t be surprising for the Japanese Yen either (the equivalent being AUDJPY, EURJPY, USDJPY, etc., top for a few weeks after the BoJ announces their new policies on January 22).

The long-term fundamental bias for the USDJPY remains bullish so long as the Fed maintains its shifting hawkish sentiment from the December meeting, per the Minutes released on January 3. Right now, the BoJ is readying to ease significantly, and pressured by new Prime Minister Shinzo Abe, it will maintain an ultra-dovish policy for at least 2013. Dips are viewed as constructive, and only a move back below 84.00/20 (March 2012 highs) would call for a shift in bias.

This interview was originally conducted for FX Street

--- Written by Christopher Vecchio, Currency Analyst

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