Irish Sacrifice?

As the G-20 winds down with little to no meaningful resolution to any of the problems that ail the global economy, selling in the Euro has subsided as apparently the Irish debt problem was a topic of discussion.  While it is no secret that indeed Ireland has a major challenge to tackle its debt burdens, the real problem is the rising interest rates that Ireland will be forced to pay to service that debt.

So why did rates rise so high so fast?  What changed all of a sudden to make the market fear that the Irish may default?  Well it was none other than their supposed partner in the EU, Germany and their Chancellor Merkel who spooked the markets by stating that bondholders may have to bear a portion of the losses.  While under normal circumstances this may be no big deal and the cost of doing business, it was the implicit backing of the EU that was the reason investors bought the bonds in the first place!

So today Merkel comes out and says that she was referring potentially to bonds issued in the future, and not current issues.  But why did it take so long to correct this misunderstanding?

Well the answer can be found in today’s EU GDP report which missed expectations coming in at .4% vs. .5%.  In addition, industrial production figures came in way worse than expected, posting a monthly decline of .9% vs. an expected gain of .2%.

This highlights the dichotomy that exists between different nations of the Euro zone.  It’s basically Germany and France vs. everyone else.  The Euro zone was kicking tail for a while when the Euro was trading around 1.20.  They don’t do so well at Euro 1.40.  With US QE2 driving everything but the Dollar higher, the Germans figured they could induce some Euro weakness by bringing back the debt crisis.

Unfortunately for Ireland, they have become the sacrificial lamb.  Of all of the PIIGS countries, it basically came down to Ireland or Portugal.  Greece has already accessed the emergency facility so they were out.  Italy appears to be OK and able to handle itself.  Spain is way too big of an economy to let fail, even though their problems may be bigger than both Ireland and Portugal combined.   Portugal’s problems may not be as great as Ireland’s, but they may be quicker to fall.

So the market pushed yield spreads on Ireland and Portugal to new heights, all but forcing Merkel to back away from her comments.  While the Irish are undertaking Draconian measures to get their debt under control, Merkel had better be careful next time.  For if the Irish believe that their austerity will be all for naught, then they just might forgo it and continue to party; leaving Germany to clean up the aftermath.

In the forex market:

Aussie (AUD):   The Aussie is lower but bouncing back some after major overnight selling in the Asian equities markets has induced risk aversion and unwinding of carry trades heading into the weekend.

Kiwi (NZD):   The Kiwi is also lower for the same reasons as the Aussie.  In addition, there is speculation that China may raise interest rates to cool their inflation which could mean a slowdown which would affect both NZ and Australia.

Loonie (CAD):   The Loonie is lower across the board for one main reason: oil.  Oil prices have fallen as low as to 86 this morning as a potential Chinese slowdown could hamper demand for crude.

Euro (EUR):   The Euro is trading higher across the board despite the risk aversion to start the day as Merkel was forced by the G20 to stop the ruse.  GDP figures came in below expectations as did industrial production figures.  But yields came tumbling down on Irish and Portuguese debt as investors became more confident that they won’t be on the hook.  This situation is far from over though, as these yields are still very high.  So it was a volatile morning for the Euro.  (Click chart to enlarge)

Pound (GBP):   The Pound is bouncing back nicely as well this morning despite consumer confidence figures that came in lower than expected.  The UK is closely associated with Ireland, despite not being part of the EU.  So the fallout from the Irish debt crisis was a secondary factor weighing on the Pound, which could be higher if not for it.

Dollar (USD):   The Dollar is mixed this morning as Euro and Pound strength is countering risk aversion and commodity currency weakness.   Consumer confidence figures are due out later this morning, and we have some Fed speak today.  The US was entirely unsuccessful at the G-20 with regard to China.

Yen (JPY):   The Yen is also mixed as earlier strength as a result of the negative correlative effects of lower Asian equities is waning.   Also, risk aversion is appears to have lessened as well.  (Click chart to enlarge)

So once again the US completely failed at the G-20 and things will continue to be status quo until the next crisis happens.

Meanwhile, Germany appears to have a death wish and is playing a dangerous game of chicken with the markets as they appear able and willing to sacrifice other EU members to eek out a few more GDP points.  Lest the Germans forget, it is actually the inclusion of the Irelands and Portugals of the world that allow them to compete in the global economy as well as they do.

For if the Germany had to go back to the Deutschmark, then that might be one of the strongest currencies around.  Then they would cry foul that a higher DM hurts their exports and would be with Japan in the intervention game.  So be careful what you wish for!

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