One of the burning questions that will vex global
investors in 2017 is whether the euro will still be in existence by the end of
the year. That may seem a bit of a shocker to think of as the euro enjoys a
spell of short squeeze. But, without a doubt, the single currency looks set to
have an extremely rough ride this year.
A dangerous cocktail of negative factors will prove
its undoing this year. Weak economics, dodgy money, bad budgets and ugly
politics will all have it in for the euro. Euro zone policymakers will be
pushed to the limit to stop the currency going over the edge of a precipice.
The euro has a precariously weak footing right now, perilously
poised above parity against the US dollar, leaving a plunge below EURUSD 1.0 a
high probability in future months. It is not just the dollar on a rampage, but
the realisation among global investors that the single currency has been
skating on thin ice for far too long and cracks continue to spread at an
alarming rate.
Weak economics remain at the root of the currency’s
vulnerability. Germany may be showing some better glimmers of life going into
2017, but, outside, most of the euro zone is a zombie economy, kept alive by a
surfeit of cheap and easy money from the European Central Bank’s super-stimulus
programme. It’s not going to last forever.
There is no plan to cut back the ECB’s
asset-purchase programme just yet, but clearly there are already discussions
going on in Frankfurt backrooms to kill QE at some stage. Germany is at the
front of the queue calling time on the ECB’s unprecedented monetisation and the
clamour for policy normalisation will intensify, not least because euro zone
inflation is staging a comeback.
The ECB’s favoured inflation indicator, the 5-year,
5-year break-even forward rate, is already back up to 1.76 per cent after
touching a 1.3 per cent low last year. This will be setting off ECB alarm
bells, especially as the demand for credit has accelerated very sharply in the
last two years. Worries about asset bubbles forming will only harden Germany’s
resolve to stop the monetary overkill as soon as possible.
Once QE’s taps are turned off, that’s when the
trouble starts. The ECB has extended asset purchases until December 2017, but
tensions will surface long before then. Short term interest rates and
longer-dated bond yields will start to rise in anticipation of the ECB’s ‘taper
tantrum’. Germany’s economy may be better-placed to deal with higher borrowing
costs, but the weaker euro zone economies will be left in the lurch.
With the ECB’s cheap money crutch kicked away,
consumers, businesses and investors in the more vulnerable euro zone economies
will start to feel the pinch. Unemployment rates in Italy, Spain, Portugal and
Greece are still too high and economic confidence levels still too low to
warrant any extension of spontaneous recovery.
Without the ECB’s monetary pump, these economies
will be in trouble again pretty quickly. With burgeoning budget deficits and
groaning government debt piles – 183 per cent in the case of Greece – there is
nothing left to reflate recovery, unless it comes from Germany re-cycling its
fiscal surplus. And the odds of that happening are about as high as hell
freezing over.
It is no surprise European public opinion is
splintering and euro scepticism and political populism are on the rise.
Britain’s Brexit vote last June opened up a gaping wound in the EU’s formerly
cohesive political centralism, leaving EMU and the euro in dire danger as
Europe runs the gauntlet of key elections in Germany and France in 2017.
The benchmark test is most likely to come in France,
especially if the political fulcrum tips towards the far-right and the risk of
a future referendum on continued euro membership. Without France, it would be the
end of the road for EMU, the euro zone and the euro – quite possible even the
EU. The euro bears would have a field day. The old 0.8225 euro-dollar low would
be blown away very quickly.
Chaos would ensue. Divergence trades would go
ballistic, there would be a major flight out of global risk assets and safe
haven demand would go through the roof. In short, global investors would be
praying for the return of the old German mark for salvation.
2017 will mark a perilous time for global investors
as the euro finally meets its nemesis.
