With many expecting 2012 to be a replica of 2011, at least for US stocks which the non-permabull consensus sees closing the year largely unchanged for the second year in a row, one open question is whether this will also be applicable to Europe. As a reminder, the EURUSD opened this year near the 52 week lows, only to rise by several thousand pips as concerns about European contagion were brushed away on hopes Europe's politicians had it "under control." They didn't, and the EURUSD returned to its year's lows recently. But is the same pattern in store for early 2012, where as we already noted, the bulk of gross debt issuance is due to take place, especially in January? Below are UBS' 5 other key reasons why the European resurgence (however brief) that was experienced early this year will not be recreated in the new year that is now just around the corner.
From UBS:
From UBS:
So how do we expect the Eurozone crisis to evolve in early 2012 and how will it affect the euro? Last year, most observers expected Q1 2012 to bring an escalation of the crisis, particularly on peripheral bond markets. Instead, the periphery rallied and so did the euro, from about 1.30, just where we are today, to almost 1.50. Could the same happen early next year? We do not think so for the following reasons:
1) The ECB
In early 2011, the ECB sounded hawkish and then went on to hike rates in April and July, just as the Fed prepared to embark on QE2. 2012 will arguably be very different as the ECB is likely to cut rates to a new historic low of 0.50% and might well then embark on outright QE. At a time when the Fed looks largely done with its QE efforts, this could hit EURUSD hard and for us is the single most important reason to be structurally bearish the euro in 2012.
2) Greece
There is now a non-negotiable deadline for the Greek PSI, which is the bond redemption on 20 March. Negotiations for the new troika programme continue to assume a ‘voluntary’ PSI resulting in a 50% haircut and a debt-to-GDP reduction to 120% by 2020. However, revenue shortfalls due to the deeper-thanforecast recession look set to result in additional financing needs, which in the absence of new official money might mean a larger haircut and hence a coercive restructuring.
3) Contagion
If Greece is forced to impose an involuntary restructuring on investors, the market might quickly move on to Portugal or even beyond. Eurozone leaders have frantically worked at erecting a ‘firewall’ for countries beyond Greece in case of a default occurring. So far they have had limited success apart from raising more cash for the IMF and advancing the European Stability Mechanism (ESM) to mid-2012. Still, these instruments are arguably not yet powerful enough to deal with a country like Spain or Italy loosing market access.
4) CDS
The above Greek scenario would result in a credit event being declared and credit default swaps (CDS) being triggered. Many observers might welcome such an event as a proper default would mean that Greece was finally declared ‘insolvent’ and unable to pay its obligations, which most would argue might be better for the longer term health of the system than pretending otherwise. Still, nobody knows how the financial system would handle CDS payouts of more than €80bn (gross). At least as an initial reaction, the market would probably be highly stressed.
5) Politics
The EU has an impressive track record in pushing through projects even against resistance from individual countries and with minimal explicit or implicit support from electorates. However, there may come a point where populations start to rebel, possibly when they are simultaneously faced with ever deeper cuts in public services and ever higher taxes. A relatively benign problem might be resistance to ESM ratification in some countries, but more serious social unrest could occur both in debtor as well as creditor countries.
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