EUR/USD (1.3625) If the euro is to survive, the eurozone must work out a fiscal union, according to the two newest Nobel economics laureates on Monday. Based on the rational expectations theory, Christopher Sims and Thomas Sargent recognise that government spending is less effective when people see limits to public financing and eventually expect the stimulus to run out and taxes to rise. The same applies to the US. The economists criticised the way the US government discusses fiscal problems, and suggested that sustainability is a question of which of its promises will be broken, pertaining to taxes, health care, or pensions.
The euro continued its positive streak on the Franco-German pledge to defend the single currency through bank recapitalization. Saying that they are determined to do whatever is necessary, the two leaders offered no details of their plan, a move that seemed to pay heed to the expectations theory. However, the price moves in the stock markets, yield spreads and in the euro (largest one-day rally in 15 months) suggest that, rationally or otherwise, those expectations are very high indeed. We now consider the euro stable while it trades above 1.3345 and see room for additional modest gains to 1.3710 and to 1.3800. Demand on dips has also improved now at 1.3520 and at 1.3380.
Market Bias Index
With the exception of the CHF, which is a special case anyway, the levels of generalised bias are now at their lowest in about three weeks – the dollar and the euro are largely perceived as fairly valued.
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Deutsche Bank
Fixed Income Research – Global