The last couple of trading weeks have brought subdued movement and a slow grind higher in U.S. equity, commodities, and a sell of in quality through the treasury market. Central Bank confidence has kept investor fears to a minimum as the S&P 500 is less than 1% away from a 4 year high. European banks have also seen a massive rally over the past couple of days. Everything seems to be quite fine!
This market phenomena (central bank confidence rallies) can continue on for potentially weeks to even months, even with significant downside risks outside of the United States (can we say “Europe”). However the structural flaws of the Eurozone and the major threshold stress levels that have been passed should be obvious that Europe’s problem is far from over.
The Structural Flaw of Europe
It should be obvious that the major problem with Europe is that it was built as a monetary union, but without a fiscal union and banking union. By not having a fiscal union, it takes much more time to make important decisions, usually when it is too late. However the real plague is having a monetary union without a banking union. Why?
It is quite simple really, when worsening Eurozone countries such as Greece, Spain, & Italy begin / are experiencing capital flights, deposits are immediately exported out of the country in trouble, into stronger Eurozone countries. This capital flight essentially does not devalue the currency as deposits are NOT transferred into another currency. In a real capital flight from a country with their own currency, the selling of that currency would devalue the currency, and thus in the end make the country more competitive and attractive for investment. This does not occur in the Eurozone as banking systems are separate per country along with the monetary union.
In other words, Europe’s problems aren’t going anywhere. Although we will probably see a rally in risk in the coming weeks due to capital coming out of quality, central bank support, and low volume trade, be sure to be nimble for the reversal should come!
Marchese Financial 