Despite European leaders agreeing to recapitalise banks directly instead of bailing them out vis-a-vis loans, Barclays believes that the Euro currency will be weak and will fall

Barclays, a leading British financial institution, believes that the market is expected to remain subdued if not fall despite European leaders buying more time to contain the prevailing European Union (EU) crisis. By agreeing to recapitalise Spanish banks (a first time measure taken by the EU), a landmark move, while at the same time denying ‘seniority’ on its sovereign bonds, Barclays believes the euro will continue to remain weak even though the euro has rallied against the dollar. In a recent report titled “EUR: EU Summit is not a game-changer for the EUR” it said, “We remain bearish on EURUSD (Euro-Dollar), expecting it to grind slowly down to 1.15 over the next 12 months. We therefore suggest investors look to fade this morning’s European currency strength versus the USD and non European commodity currencies such as the AUD (Australian Dollar) and CAD (Canadian Dollar).” The term ‘fade’ used in this context means to lock profit and get out of the investment/position (or go short).

Zerohedge, a popular finance blogger followed by many, has a different perspective of the same situation. According to the blog, it said, “for a real fiscal and monetary policy intervention to take place i.e. a rescue package that lasts at least a few months, as opposed to (today’s) several day max rally: the market has to be tumbling. Everything else is (quarter end) window dressing.” In other words, the markets will have to fall by a significant margin for central bankers to take notice and inject sufficient capital into the system vis-a-vis “quantitative easing”, in order to shore up the financial system. Barclays expects the “European Central Bank (ECB) to keep its monetary policy very loose for some time and to cut rates by 50 basis points (bps) next week, a move which is not fully priced in by the market.” The US Fed has already ‘indicated’ that it might pursue QE3, its third wave of printing dollars.

The only piece of good news in the report was that there could be “sustained support” in market sentiment. “We expect the general improvement in sentiment to have legs because the measures announced to tackle the dislocation in the banking sector,” the report said.

Moneylife had written earlier about the (unhealthy) impact of sentiment on the markets, and that is had to be supported by strong fundamentals, which has not been witnessed yet, as the details of the landmark agreement seems very patchy.

Berlin is still digging its heels and creating conditions for the bailout, which is creating viciously charged political atmosphere, which is another aspect that weakens the case for a sustained market rally in Euro currency. German chancellor Angela Merkel said, “countries must fulfil conditions for bond-buying programmes that the Troika must check”. Ms Merkel has been very vocal against bailing out flailing economies directly unless those economies adhere to strict conditions under the new treaty. Her statement is a testament to her reluctance to stand by the weaker economies.

According to Associated Press sources, the new treaty includes:

•    Bailing out economies directly by a central body, instead of loans through governments that already have too much debt.
•    Lowering the borrowing costs on Italy and Spain, the euro region’s third- and fourth-largest economies.
•    Rescue floundering countries, without forcing them to make painful budget cuts if they’ve already made economic reforms.
•    Tie their budgets, currency and governments more tightly.

The Barclay’s report further believes that the agreement to inject the Spanish banking system with cash will only cause the banks to increase their debt levels, which is not an ideal outcome. It said, “The agreement to allow Spanish banks to be directly recapitalised from the European Stability Mechanism (ESM) is conditional on a single supervisor for euro are banks being established. This is not expected until the latter half of this year. In the interim, aid to Spanish banks will continue to inflate Spanish sovereign debt levels.” ESM is a bailout fund created by the European Union to bailout banks and such.