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Buy EURO Rumor; Sell Hard Fact, Tact Worth Preserving?
The full barrage of Euro-zone PMI released earlier was not too far off expectations. If anything, the French data came in better than expected, with the service sector report up to 43.7 versus expectations of an unchanged final reading (42.7). The German data is also stronger than expected, where the services PMI bounced to 54.7. The official gap between the euro-zone's two largest economies-Germany and France- is officially now at its record widest and reflects the dramatic difference between the two economies. For Italy and Spain, the euro-zones two other major economies, the services PMI were 43.6 and 44.7 respectively. This seems to be par for the course for the peripherals, and if anything, a better showing given the uncertain Italian political situation and its effect on their domestic economy.
Rate decisions by Central Banks will get to dominate most of the remaining market rhetoric this week. The ECB certainly remains on tender hooks with about 30% of futures dealers pricing in a refi-rate cut on Thursday. With Europe's third largest economy, Italy, struggling to form a government and being exposed to higher funding rates certainly supports the ECB's rate doves in the short term. However, clear concise ECB rhetoric can be just as effective, easily preparing money markets for a rate change rather than the action itself. Euro policy makers make it a habit of not been too directly adventurous; there are too many members to appease.
With Italian debt and equity markets trading overall heavy, the rating agencies are been watched carefully as an imminent downgrade rumor swirls on Twitter-sphere. The lack of a clear path towards the formation of a government and anti-austerity vote remains a threat to the Euro-zone and the 17-member single currency. Tough odds for forming a government should increase political risk. Even the ESM, a permanent firewall for the Euro-zone, is now seen an unlikely tool to be used this year as the Germans push back. This leaves the ECB's Outright Monetary Transactions (activity in the secondary and sovereign bond market), but the "terms of conditionality" requires an Italian government agreement and with none forthcoming only exposes the EUR to further outside threats.
Today, Latvia is set to officially apply to join the Euro next year. The country has effectively been on the Euro entry path for nearly a decade now, having joined the EU in 2004 and pegged its currency, the "lats," to the EUR the following year. The diminutive country now meets the key criteria for membership. It's budget deficit for this year is forecasted to be at +1.1%, its government debt stands at +41% of GDP and last year inflation number stood at +2%. By all accounts it looks like a model member to be held in high esteem ahead of the Euro-periphery nations. The country is coming through a harsh recession and continues to grow strongly after +5.5% growth last year.
Why should they take the plunge? Latvian banks will gain access to ECB's liquidity facilities and could use it this facility as a backstop in a liquidity crunch. Becoming a member should cut the country's borrowing cost, improve their credit standing, reduce transaction costs and promote outside investment due to an increased confidence perception. From an economic perspective, it opens up the trade routes with Western Europe. Latvia only needs to look toward Estonia to see how their export industry benefited since joining the Euro in 2009. Around 56% of the Latvian population is against joining the Euro, as Latvians will have to pay their share of any future Euro bailout. However this negative seems to be outweighed by all the aforementioned pluses.
Today in the US, the market is perhaps looking for a slightly lower reading on the US ISM Non-Manufacturing Index for February, expecting a drop to 55 from January's 55.2. If true, and despite being the lowest level in three-months, it would still suggest continuing economic expansion, and would support a yield move to break higher upon removal of some of the fiscal uncertainty. This could translate into improved risk appetite, especially for growth proxy currencies like the CAD and MXN. However, with central bank decisions in both countries, investors should remain somewhat reserved in in formulating a deeper commitment until all Central Bank rate announcements are known.