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Strategy Video: Keeping Tabs on Euro-Area Stability Flash Points

Strategy Video: Keeping Tabs on Euro-Area Stability Flash Points

2016-07-12 02:16:00
John Kicklighter, Chief Strategist
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Talking Points:

  • The Euro is facing systemic risk with the loss of its reserve standing threatening far more than local markets
  • Brexit, Greece's long-term issues and future EU referendums are considerable risks but lacking for obvious spillover
  • In contrast the financial risks posed by Italian banks and Deutsche Bank can readily prove contagious

See the DailyFX Analysts' 3Q forecasts for the Dollar, Euro, Pound, Equities and Gold in the DailyFX Trading Guides page.

The UK's decision to break from the European Union revived systemic risk concerns for the region. However, this isn't the only threat to stability in the world's largest collective economy. There are a range of concerns quickly bubbling to the surface now that the heat has been turned on. A threat to financial stability and/or economic trouble for such a crucial component of the global system is troubling for all market participants - whether you are investing in Euro or not.

In general, the risks the Euro faces are of two types: those that are systemic but ill-defined and those that are financial and ultimately very contagious. The Brexit vote and possible follow up referendums fit into the former category. The systemic risk to the Euro's position as a reserve currency and the economic fallout are exceptional; but like the situation with Greece, the abundance of complexity and ease in dragging it out translates into a market on pause. We will certainly revisit the Brexit, Greece and other countries' flirtings with an EU divorce frequently going forward; but they will not necessarily lead to an immediate reckoning.

Financial threats can trigger a flip in sentiment and spread to the global markets far more easily. On that front, we have a few pressing catalysts that may prompt trouble from the Euro-area more immediately. One of those risks is the fast rise in fear surrounding the Italian banking system. A glut of bad loans at Italian banks is pressuring a decision to be made that doesn't have a good/positive outcome: bail-out the banks and run afoul of EU colleagues or bail-in and deliver losses to the many Italian retail investors that gained exposure to the at-risk assets. Another high profile risks is Deutsche Bank's CoCo bonds. The market is clearly dubious of the German financial powerhouse's abilities to pay off these hybrid loans and the threat that the event touches off a broader financial panic is very real. We discuss some of the more prominent Euro-area flash points in today's Strategy Video.

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