The euro is here to stay and will eventually strengthen, according to David Bloom, global head of FX research at HSBC.
In a report released at the start of the year, he argued that although the eurozone’s fiscal crisis had worsened in recent months and that the political response had been slow and faltering, “the euro has proved resilient” — despite regional bond and equity prices.
The strong external position of the currency and expectations that a solution will be found for its problems, means that a final resolution “is the most likely outcome” — which would mean closer fiscal coordination or union that is already underway, and helped by less negative news flow.
In an interview with FinanceAsia on Friday, Bloom highlighted the unique aspect of the current euro crisis. “The fate of the euro in currency markets is being determined by government debt auctions and fiscal policies; that’s in contrast to pre-1994 when inflation was the market’s main concern and for many years after 1996, when it focused on short-term interest rates and carry trades. FX is now being valued through the bond markets.”
Meanwhile, market participants are looking for safe havens rather than ways to make money. “The US dollar and the euro are locked in an ugly contest, but the US dollar has the attraction of liquidity,” Bloom said.
On the other hand, he pointed out that the ECB has more flexibility to increase the size of its balance sheet while a longer-term solution is worked out.
“If the ECB were to increase its balance sheet in the same proportion [as the US Federal Reserve through quantitative easing since 2008], this would imply a potential €2 trillion ($2.5 trillion) of bond buying would be possible.” Printing money, with the ECB acting as a back-stop in the same way as the Fed and the Bank of England, would boost confidence in the bond markets and primary sovereign debt auctions.
Most critically, in the opinion of HSBC’s team of economists led by Stephen King, the costs involved in fixing the institutional weaknesses of the eurozone are far lower than the costs of failure.
It is not simply a choice between bailing out profligate members or destroying economies through excessive austerity policies; unless a resolution or synthesis of the extremes can be reached, the consequences would be dire.
“If the euro were to break up, the continent would slide into a depression similar to the 1930s,” said Bloom. And besides, any new, independent German currency would quickly become over-valued, harming the country’s exports — witness the rapid strengthening of the Swiss franc last year, as it attracted cash seeking safety in the storm.
The message is clear: a breakup of the euro is untenable, politically and economically. Meanwhile, markets will continue to react and fluctuate in response to bond auctions and news flow.
In the FX markets, “politics is the new economics”, concluded Bloom.