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Tuesday, 24 October 2017

The Brussels Accord: taking away flexibility is not the answer

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Anthony Peters, SwissInvest Strategist

There will be plenty to do today in trying to assess what the outcome of the EU summit meeting really means. The UK media are only interested in Prime Minister David Cameron’s decision to walk away from a comprehensive agreement but have yet to look closely at what we have ended up with. I shall briefly adopt the position of a little Englander and ask why all the promises which were made last night in order to achieve an agreement amongst the 17 eurozone members should be expected to be kept any more than all the promises which were made in the past, the flouting of which has got us to where we are?

I am sure that somewhere in the works of Jean de la Fontaine there is a fable which suits the current position and if not I’m even more sure that there should have been.

“Jiminy Cricket” asked me earlier on in the week how it could be that fines were to be imposed on those who broke the rules of fiscal discipline when the outcome was that they were financially distressed and that therefore the last thing they’d be able to do would be to afford to pay a fine. I had to laugh because we were asking that very same question when fines were introduced in order to enforce the Maastricht Criteria and so far as I know, not one sou has ever been paid in fines.

A large part of the European economic and currency crisis has been brought about by countries signing up to agreements which they have no way of complying with. I fear that by removing even more of the levels of interpretative flexibility from the multilateral agreements between the divergent economic units which make up the eurozone and the EU, the problems will, in the medium term, be compounded rather than defused.

Market reactions to the events in Brussels must be treated with extreme caution as they are happening in the run-up to the year end of an extremely tricky and volatile year and one where flight to quality trades will find themselves being reversed not because they are no longer pertinent but because of investors’ need to realise some profits before the end of the accounting period.

Mid to late December is usually dominated by technical trading, portfolio adjustments and snuggling up to the indices and not by fundamental position taking. We should therefore all be cautious about reading too much into currency, curve and equity price movers which are currently taking place. As at yesterday’s open, the iTraxx Xover index was bid at 700. 24 hours later it is at 778; try to work that one out.                                                          

Reading Draghi

Markets sailed in and out of air pockets after the ECB rate decision yesterday as markets try to work out whether good things are bad or whether bad things are good in terms of future outcomes – is a rate cut good news because it stimulates or bad because it confirms weakness? ECB President Mario Draghi tried very hard in the post-meeting press conference to say the right things but markets are so super-sensitive that even an impassive sphinx-like smile would be taken to have some subliminal meaning and would be dissected by specialist ECB watchers of which there are now suddenly thousands.

This morning Draghi will be forgotten and markets will have to decided whether they like what they are being told. The first response is not exactly glowing with optimism but as weak as we open, we could just as easily close the day on a wild rally. Let’s face it; markets are trying to price an uncertain outcome and that is something they are indeed very, very bad at.

I fear that by removing even more of the levels of interpretative flexibility from the multilateral agreements between the divergent economic units which make up the eurozone and the EU, the problems will, in the medium term, be compounded rather than defused.

I read of the Europeans wanting to shift US$267bn to the IMF, of European banks needing €115bn in new capital, of 100bn here and of 100bn there, of leveraging the EFSF, of the ECB buying hundreds of billions of bonds and all I can think of are the wise words of Steve Beck at Citibank who keeps on reminding us that we only have one planet on which to find this money.

I shall now try to describe a graph in words: imagine a long term trend line for economic growth at around 2 1/2%–3%. Now imagine economic growth which was, fuelled by leverage, where the actual growth line took off exponentially. Imagine the gap between trend and actual. What we need to achieve is a reversion to the long-term trend line. We can either do that with a sharp reversal back down to the trend line by way of a short, sharp recession followed by moderate trend growth or we can flat-line the economy for a long period of time until trend growth catches up with us.

One option we do not have is to grow from here without returning to debt-fuelled growth which we realistically cannot do; the best which can be done is to rearrange the deck chairs on the Titanic if everyone is to survive. The Brussels accord will bring no short-term solutions and the long-term outcome is at best uncertain. However, it is the best we can hope for. British (and other) eurosceptics might be so bold as to remember that their great hero, Winston Churchill, faced the impossible and the inevitable and refused to bow to it, thus setting the scene for a positive result against all the odds.

Alas, it is that time of the week again and all that remains is for me to wish you and yours a happy and peaceful week-end. It is the time for Christmas shopping so may you be doubly lucky and find what you can afford as well as to be able to afford what you can find.                   regards

P.S: I was off for a few days this week dealing with some personal issues. I was very touched by the many messages I received wondering whether I was alright. Thank you for the concern and I can confirm that I am alive and kicking and greatly looking forward to the Christmas break.                                             

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