German Mettle?
An update from the currency exchange firm World First.
”People think we are in a mess. We are.” George Papaconstantinou, Greek Finance Minster.
I had the opportunity to sit next to an eminent economist at a reunion dinner on Saturday. The former chief Labor economic adviser now specializes in financial regulation and he certainly had some interesting comments on the current sovereign debt crisis in Greece, what it could mean going forward and why it highlights the problem of trying to use a unified monetary policy to control such disparate economies.
Interestingly, the whole crisis could be averted should Germany come out and publically guarantee the debt. However, this is a risky strategy even though the Germans hold the largest percentage of Greek debt. The number of countries behind Greece with the potential for similar problems has been well documented and the precedent set could be rather dangerous. The cost of insuring against sovereign default soared in January and the concern that the loss in confidence in sovereign debt, especially US treasures, considered the world’s risk free asset, could have calamitous consequences for the still fragile recovery. Exaggerated fears of sovereign risk could prompt governments into premature fiscal austerity, which could push the world economy back into recession.
In spite of this, the Germans are less than willing to come out and make this statement because, as the premier global manufacturer, they are seeing the euro weaken and with it increasing the competitiveness of their goods in the market. They will have been especially keen to see the large EURUSD move over the past few weeks with many in Germany rubbing their hands with glee.
If you compare the UK to Germany, the argument for a weaker GBP becomes stronger with time and is testament to the ability of the UK to set its own monetary policy. As we have mentioned before, this allows the Central Bank to control the supply of money, availability of money and the interest rate. It has been essential in guiding the country through recession and has enabled a very close degree of control to be exerted over the economy, the lack of which some European countries have deeply missed.
The news that the UK Government still had to borrow in January, when historically incoming tax receipts sure up finances, was a stark reminder of the fragility of the recovery ahead. If the predicted exaggeration of sovereign debt risk is born out it would have catastrophic consequences on the recovery as the Government would be forced into a premature period of austerity. The need to not turn off the taps too soon versus need to sure up the debt position in the country to something resembling sustainable are the two conflicting worries that keep ministers up at night.
The complex relationships between sovereign debt and the foreign exchange market can be seen more now than ever before and with the Germans eager for a weaker euro it would be foolish for Britain to think that a stronger pound would do the economy any favors at the present time. So while both the UK and Europe would like to see a stronger pound, it might be to the detriment of the recovery. You can’t always get what you want, but if you try sometimes, well you might find you’ll get what you need.
Trade of the Week
This week’s trade of the week is a Tarn Convertible. This structure combines the ability to buy above the current market price with the ability to gain should the market move in the client’s favor.
The way a TARN works is the client has a strike rate above the current market, in this example at 1.61 on GBP/USD, and a “bucket” of figures to use, let’s say 17. If the market is trading at 1.52 then the client will get 1.61 and have to spend 9 figures from their bucket. The next month they have 8 figures to spend and this continues until the bucket reaches zero or the term of the structure comes to an end.
If the market is trading above 1.61 then the client is able to benefit up to a level of 1.66 without using any of their remaining figures in the bucket. If on the day of expiry the market is trading above 1.66, the client is obliged to buy his dollars at the strike rate of 1.61.
This trade works for both buyers and sellers of sterling and is available against other currencies (euro, yen, Aussie, Kiwi).
For more information, see World First.
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