EUR has tremendous resilience and USD has more than one giant weakness

	SPOT	CURRENT POSITION	SIGNAL STRENGHT	OPEN DATE	OPEN RATE	POSITION GAIN/LOSS
USD/JPY	83.89	LONG USD	WEAK	11/15/10	82.51	1.65%
GBP/USD	1.5627	LONG GBP	WEAK	12/14/10	1.5870	-1.53%
EURO/USD	1.3338	LONG EURO	WEAK	12/14/10	1.3459	-0.90%
EURO/JPY	111.90	LONG EURO	WEAK	12/15/10	111.71	0.17%
EURO/GBP	0.8534	LONG EURO	WEAK	12/15/10	0.8466	0.80%
GBP/JPY	131.11	SHORT GBP	WEAK	11/24/10	131.33	0.17%
USD/CHF	0.9586	SHORT USD	STRONG	12/14/10	0.9624	0.40%
USD/CAD	1.0070	SHORT USD	WEAK	12/13/10	1.0086	0.16%
AUD/USD	0.9870	LONG AUD	WEAK	12/14/10	0.9993	-1.23%
AUD/JPY	82.79	LONG AUD	STRONG	12/09/10	82.55	0.29%
USD/MXN	12.3939	LONG USD	WEAK	11/30/10	12.5035	-0.88%

Outlook

That EMU leaders could come to an agreement at all is a victory of sorts, but the IMF’s Strauss-Kahn is right, the tone and mentality is wrong. The emergency bailout mechanism addresses only crisis situations in peripheral countries and fails to deal with the very real core structural problem of the EMU, that it lacks a Treasury. Analysts speak of “transfer capability” and the need for fiscal union, but at heart, what is missing is the traditional pool of sovereign wealth that backstops bond issuance. Germany, of course, opposes the e-bond, but you don’t have to issue new bonds to foster confidence by having the means to do so—look at Canada. The failure of the eurozone is not just bad management and mistakes in a handful of peripheral countries—it’s the absence of a European sovereign identity that is backed by cold, hard cash. The ECB’s capital at some €10 billion is no substitute for real reserves. We respect China as an economic powerhouse in part because it holds nearly $2 trillion in reserves, and Japan is able to have debt at twice its GDP because of its reserves and because its own citizens buy the debt. Even the US has over $350 billion in gold in Fort Knox (in addition to currency reserves).

It’s hard to see how the inadequate institutional response to the debt crisis in Europe will not  become a hobby-horse for traders in the New Year. “Speculators” will surely see plenty of opportunities to make a quick buck by shorting something. Traders like crises, especially when there is something real to get their teeth into.

The real culprit may be inadequate bank capitalization to overcome upcoming losses on sovereign paper, but the target will be the paper itself, not the banks. In the US, the TARP program, while unpopular, had credibility. The stress tests were derided as wallpaper, but also buttressed confidence.

Part of the European problem now is that it’s only the central bank holding a hot glue-gun that is preventing a wider sell-off. Everyone respects Trichet but he doesn’t have a deep enough pocket to fend off all comers. The US has hardly solved the source of it banks’ losses—mortgage-backed and related assets—but it has a legal framework and institutions beavering away at them, including the state attorneys general of all 50 states. The European have no joint institutions and no mechanisms to repair the core problem of excessive sovereign indebtedness, and are showing themselves unwilling to create them.

Still, the euro has tremendous resilience and the dollar has more than one giant weakness,  including the twin deficits and so far, no viable fiscal plan or commitment to better fiscal management (as we see from the unfunded tax cut extension). Rising Treasury yields based on improving growth are nice but vulnerable. If they start falling or rising only because investors fear inflation and lack of global demand for US paper, it’s a big, fat dollar negative. Another vulnerability is the parlous condition of state and local finances—the muni market. As Market News points out, it was an odd crisis and is turning into an odd recovery. “The Great Recession  has been unlike anything we have ever seen. The Great Recovery might be the same.” Since the standard bias is anti-dollar, we are not betting just yet on a euro rout, logical as it seems.
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