The euro is embarking on a downward journey

Outlook:

The fiscal cliff, if not revised and repaired, will cause the US economy to contract by 0.5% next year, not much in the usual scheme of things but pretty scary in light of growth at under 2%. And yet it’s not so bad in comparison to current growth in Europe and expected contraction next year. To the extent currency levels reflect relative growth rates, the US is a winner. Hysteria over the fiscal cliff is premature and wrong-headed. Even if we get a bad outcome—the Administration still can’t get a deal—the US is not likely to go into outright recession. Meanwhile, housing is a ray of light. 

At a guess, the euro is embarking on a downward journey that reflects authentically dire conditions. You can’t imagine economic recovery, let alone speedy recovery, when two countries have a quarter of their population unemployed. We say the chart of the euro/yen reflects this new appreciation of the depth of the problem. Japan has a worse debt problem than anybody in G10 and yet it manages to get growth, if sporadic and choppy, and no unemployment crisis. We think the dollar and yen have a good chance of continuing on their current path, especially if Rajoy and Draghi continue playing cat and mouse. 

• The IMF predicts a 80% probability of eurozone recession in 2013. The European Commission cut its eurozone growth forecast to 0.1% in 2013 from 1% in May. German growth was cut in half to 0.8% from 1.7%.

• The WSJ estimates capital flight/deleveraging credit contraction by $2.8 trillion in assets by end-2013

• German thank-tank forecast EMU growth at -0.5% this year and +0.1% next year.

• S&P cut Spain's rating two notches to triple-B-minus, one step over junk, and Moody’s has the same rating (Baa3), also one notch over junk. Moody’s cut the ratings of half the Spanish regions. S&P cut the SocGen rating by one notch and issued a negative outlook for the other two big French banks on deteriorating conditions.

• The EU banking supervisor will be established by year-end but may not have the authority to recapitalize the Spanish banks for another 6-12 months.

• Greece needs the additional €30 billion in bailout money. The deadline is a bond redemption on Nov 16.