The Euro Currency And The Weakening European Economy

By Alan Bush, Archer Financial Services

There is growing evidence that the economy of the euro zone is stagnating and, in fact, is probably getting worse. While the financial crisis in Greece is off the front pages, at least for now, the financial problems in other euro zone countries are coming to the forefront, especially Spain. There was only temporary support for the euro after a board member of the European Central Bank suggested the central bank might buy Spain's sovereign debt.

Spain

Some of the recent headlines focusing on the latest potential European Union bailout candidate, Spain are:

• Spain's government increased its budget deficit target to 5.3% of gross domestic product from 4.4%. They also said public debt could surge to a record 79.8% of gross domestic product in 2012.
• Yields on Spanish debt continue to increase, which underscores Spain's weakening financial condition and suggests there is a growing possibility that Spain may need a European Union bailout.
• The yield on Spain's 10-year debt recently increased to the highest rate since the middle of December. There were additional concerns after Spain sold less debt at auction than was targeted.
• Analysts were not impressed with Spain's latest austerely plan, which calls for 10 billion euros of budget reductions. This amount is thought to be insufficient.
• A recent report showed unemployment in Spain increased again in March.
• The share prices of Spanish and Italian banks have recently come under selling pressure. One day recently, they were down by as much as 3%.
• A European Union spokesman said banks in Spain will not need a bailout. (This comment this tells us just the opposite. The denial suggests most Spanish banks will need bailout money from the European Union.)

Greece

• The recent Greek debt bailout is already starting to show it may have only a temporary supportive impact, especially after Standard and Poor's said Greece may have to restructure its recently restructured debt.

Euro zone

• German unemployment declined more than anticipated in March.
• A recent report showed the euro zone manufacturing sector contracted for eight consecutive months.
• German retail sales unexpectedly declined in February for a second month.
• An index of economic confidence in the euro zone unexpectedly dropped in March.

Federal Reserve Policy

Interest rate differentials (U.S. interest rates compared to euro zone interest rates) remain bearish for the euro currency and favorable for the U.S. dollar. The euro came under pressure earlier this week due to the bearish influence of the Fed's lack of interest in initiating another quantitative easing program. On Monday evening, Federal Reserve Chairman Bernanke refrained from discussing monetary policy, suggesting the Fed is not planning a third quantitative easing program, when he spoke on the topic of financial stability at the Atlanta Fed Conference. Several other Federal Reserve officials said, given the recent economic improvement, there is no need for a third quantitative easing program.

The euro was pressured and the U.S. dollar was supported after the minutes from the March 13 FOMC meeting were released. The minutes showed that, even though Fed officials remain cautious about the economic outlook, there is little, if any, support for any new quantitative easing program. Only a few members of the committee were in favor of more accommodation. The lack of any new hints of a QE3 program tended to increase U.S. interest rates relative to euro zone interest rates, which is bearish for the euro.

June 2012 Euro Futures - Daily

Chart provided by APEX

CONCLUSION

There is a widespread belief among the investment community that the financial crisis in the euro zone will continue and possibly get worse. There is speculation that the financial problems that plagued Greece will eventually spill over to Spain and Portugal. There was only temporary support for the euro currency after euro zone finance ministers decided to increase their overall bailout capacity to 700 billion euros. There was disappointment due to the belief that the increase in bailout funds may be insufficient.

The longer-term underlying fundamentals remain bearish for the currency of the euro zone, including prospects of the euro zone economy slipping into recession this year, while the U.S. economy is showing signs of improvement. Our analysis suggests economic weakness in the euro zone will be prolonged. The main trend for the euro currency is lower.