It May Be A Weak Dollar Story, But Europe Is Center Stage In The Week Ahead

On Tuesday, the UK will broaden its attack on the Withdrawal Bill that the government negotiated, and the government waged a successful election. The tax bill that the government will propose gives UK ministers the unilateral authority to determine which goods sent from other parts of Great Britain to Northern Ireland should be subject to tariffs. The UK's damage inflicted by these legislative moves and the attitude it reflects sours the mood and weakens the necessary trust.

The market, which had strongly leaned in favor of an eventual agreement, is having second thoughts. The broad dollar decline may conceal what is happening. Sterling has given back half of the gains scored against the euro over the past three months. In the options market, the one-month skew (risk-reversal) has surged. In the middle of last week, favor euro calls by nearly 2.4%, twice the 200-day moving average and the highest since the disorderly market in March, before consolidating in the last couple of sessions.

Lastly, it is important to keep in mind that the transition promises to be chaotic even with a trade agreement. Places that did not have custom checks and inspection of animal products will now have them. Necessary documents and registrations multiply. Even in the best of circumstances, the end of the standstill arrangement will be disruptive and a drag on growth.

At the same time, next year's EU budget is being stalled. Officials chose to run their joint recovery fund through the EU rather than a eurozone institution and incorporated it into its seven-year budget plan. Some decisions require unanimity, and others a qualified majority. The decision to link the recovery fund to respect for the rule of law was decided by a qualified majority. However, the overall deal, especially because it calls for joint debt issuance, requires unanimous support. As much as one recognizes the core significance of the rule of law, doesn't it seem politically naive not to have anticipated Poland and Hungary's dissent, to whom the measures are clearly directed? 

The EU leaders summit on December 10-11 will have to take this up. One tactic could be to try to split Poland and Hungary apart. The cost would be great, but it did reach for something that was outside its grasp, like encouraging Ukraine to seek NATO membership.

A deal Poland has hinted it could support is that it drops veto now for 1) not accelerating the emissions reduction target, which falls most heavily on the eastern and central European countries who more reliant on coal, and 2) preserving the right to sue the EC later over tying the assistance to the rule of law. 

The press reports that the EU would simply proceed without Hungary and Poland in setting up the 750 billion euro recovery fund. While apparently legally possible, it would seem to set a dangerous precedent. It would weaken the rule of law by circumventing the spirit that required some unanimity in decision-making in the first place. As the EU has grown, qualified majority voting has increased, but there are still rules, and there are legitimate ways to change them. This is not one of them, and it runs loose with the sensitivities to the tension between intergovernmental and EU decision-making.

A fight is brewing over another European initiative. It is trying to reform the European Stabilization Mechanism, its financial assistance arm that loans to eurozone members and can inject new funds into banks. The reforms strengthen the ESM and its role in backstopping the Single Resolution Fund and spearhead, when and if necessary, the restructuring of government debt.

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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