Germany to Directly Supervise Spain's Budget Reforms

We have long maintained that the ongoing sovereign debt crisis in Southern Europe will precipitate further European integration. (See Another Step Forward in the Creation of the United States of Europe). With the second Greek bailout a done deal, the market's attention has again shifted to Spain. Last week yields on Spanish government bonds were once again up at 5.5%.

Today Dow Jones Newswires reported that a German government delegation will fly to Madrid to

corroborate first hand the government's reforms and assess the true risk of the new deficit target

Reading between the lines this means that representatives of the German government will have a direct

Another Step Forward in the Creation of the United States of Europe

In politics crisis only brings opportunity for radical reforms. As WhatIf mentions in a previous post, the ongoing situation in Greece will only help further the fiscal consolidation of the Eurozone. And now the next step along that long road has officially been made. According to this Reuters article,

"If the Greeks aren't able to succeed themselves with... (the austerity measures), then there must be stronger leadership and monitoring from abroad, for example through the EU," added Roesler, chairman of the Free Democrats (FDP) who share power with Chancellor Angela Merkel.

Germany is thus openly asking that Greece give up a token of sovereignity in return for their next bailout. Of course this will certainly not pass this time. But the fact that this radical (some may say outrageous!) step has been suggested and is even considered, very much indicates the future direction of European integration.

Technical Bounce in Gold To Present a Selling Opportunity

The metal has bounced from a low of 1522 reached in thin trading in the last few days of Dec. The precipitous drop from a Sep high of 1920 had taken it into oversold territory amid anecdotal evidence of large funds reducing positions into year-end. There will undoubtedly be fast money playing the bounce, but should it trade into the 1650 level this would present a good selling opportunity. The fundamentals for Gold continue to be quite negative, with the world's biggest consumer, India logging a 50%+ drop in imports in the third quarter of last year (see Reuters article). The US dollar was the first major currency to suffer from the effects of quantitative easing but will arguably also be the first to recover. Since Gold has been heavily used as a bet on the de-dollarization of the world economy, one of its main investment functions is also waning.

Forget Japan - China Is Still in Treasury's Crosshairs

Much has been said in the popular press about the recent semi-annual Treasury FX report (officially Report to Congress on International Economic and Exchange Rate Policies) and how it has targetted Japan for its unilateral interventions, while again choosing not to label China a currency manipulator. See for example Reuters article. This view is not completely without merit. Indeed, when Japan last intervened in the FX markets in 2004, the Treasury described the actions purely factually without divulging an opinion. Compared to that, the current treatment does seem somewhat negative:

"...the United States did not support these interventions. It is worth noting that these operations took place at a time when foreign exchange market activity and risk aversion were being predominantly influenced by financial developments elsewhere in the global economy that were impacting all of the major currencies." (See full report)

What is important here, however, is that there has been no negative rhetoric out of Washington right after the interventions or immediately before the official publication of the report. Also the language used is still very much benign. In fact, I believe the negative mention of Japan is included to make the report appear as unbiased as possible in order to avoid giving China a chance to complain about its objectivity. And while it was not labeled a currency manipulator for political reasons (as in practice it certainly is) China and not Japan is still the main target for Washington's foreign exchange policy.

Rating Agencies Are Probably Overdoing It

Recently there has been a veritable onslaught on core European sovereigns by the major rating agencies, with S&P warning of a major wave of downgrades in Europe 2 weeks ago, then Moody's lowering Belgium by 2 notches on Friday and finally Fitch changing France's outlook to negative. The timing of the announcements is like a rush to the exit, with no one wanting to be left behind just in case. Rating agencies were considerably behind the curve during the 2008 financial crisis. They badly mispriced the correlation of  subprime mortgages and rated "senior" tranches of CDO's triple-A. Those same tranches ended up worth close to zero. Also they infamously rated Lehman double-A up to the moment it filed for bankruptcy. The painful experience 3 years ago and the ensuing investor and regulatory backlash has left the rating agencies quite trigger-happy with the downgrade button - possibly more than justified in some individual cases.