In order to sell the Euro to a sceptical German public, the farcical ‘Growth and Stability Pact’ was conceived a decade ago to constrain European budget deficits to 3%. The Germans now want a rule to prevent any deficit more than .35%. One does wonder what planet they are living on. Nevertheless, the ECB’s decision to push the ‘inflate’ rather than the ‘self-destruct’ button will have significant consequences in weakening the Euro and making European exporters more competitive – a good thing as it helps offset the fiscal contraction. Unfortunately it won’t be enough to prevent a Greek default down the track, but the macro path is now clear. The Bundesbank has been out-manoeuvred, and inflation is coming. Disaster for bonds, selectively better for equities, great for precious metals and Asian currencies.
So why have Asian currencies depreciated vs the USD over the last few weeks? We can only assume it is a function of risk aversion, as it would be very hard to characterise the fiscal position of the US as materially better than much of the Euro-zone periphery. We are inclined to think that this presents a buying opportunity, particularly for the Australian Dollar, where the fundamentals – immaterial sovereign debt, a large interest rate differential and a budget realistically forecast to be in surplus in the next few years – are immeasurably superior. The recent adoption of a few anti-mining recommendations from the Henry tax review has cast a near-term pall over the perception of investment in the country, but we note that corporate activity continues and the reality is that there is unlikely to be a sufficient majority to pass the legislation in any case. From the perspective of the mining equities it appears that a worst-case scenario was immediately priced in, making the risk/reward equation much more favourable. We have removed most of our short positions and taken off our partial hedge of the A$ vs the US$.
