Debt Sinks Currency Rally

The currency rally was stopped in its tracks last night. After watching the euro (EUR) rally to 1.3175 yesterday, I was prepared to come in and tell you all about how the Spanish debt auction results had given the euro the wind in its sails it needed. And that was the case, that is until the overnight markets pushed the single unit back down below 1.31. And when that happens, the rest of the currencies search for a bid — but find just a few crumbs of bids out there.

What happened overnight to switch gears? Finding nothing, I’m left to run this through the gauntlet in my mind as to what happened. And the only thing I can think of is even with the good results of the Spanish debt auction yesterday, traders looked around and saw that Germany was coming into the auction market today, and realized that the eurozone is nothing but spiraling debt after debt.

But a small adjustment is all they felt about that thought. As many others and I wonder from time to time, what keeps the euro so strong versus the dollar? And the Swiss franc (CHF)?

You have to think that in the ugly contest, the dollar continues to be the winner. And that says a lot, considering the rot on the euro’s vine these days. But one thing to keep in mind — yes, the people of Greece, Italy, Spain and others don’t particularly care for the austerity measures being put before them. But in five years’ time, we’ll all look back (at least I hope!) and see that at least the eurozone took steps to put a lid on their debt, if not reduce it, while the U.S. will still be mustering up the political will to do something about our debt.

Sweden’s Riksbank did leave rates unchanged, as I suspected they would yesterday. The Riksbank’s governor, Stefan Ingves, was very good in the press conference following the rate announcement. He told the audience that the Swedish economy “has bottomed” and that “the worst is behind us.”  So the krona (SEK) traded the rest of the morning with a bias to buy, but the pull from the euro has not allowed the krona to take off on its own.

The British pound sterling (GBP) did see some buying to prop up the price versus the dollar and euro this morning, when the minutes of the last Bank of England (BOE) meeting were printed and showed that the main supporter for more stimulus has withdrawn that support.

Speaking of Britain, did you see that a couple of London banks are seeking to become a hub for renminbi/yuan (CNY) trade and investment? Here’s where the markets completely miss the boat, folks. They see that story and think about more commissions. I see that story and know in my heart of hearts that should this happen, and I do believe it will happen.

China will stretch their tentacles for a wider distribution of the renminbi once more. For if you get the renminbi trading in London, that means at least a couple of large banks are going to have to provide liquidity, which means more markets for everyone else. Once this process begins, renminbi will be everywhere! And when New York banks get into the flow, it will be all over, but the crying for the dollar as the reserve currency.

Yesterday, the Bank of Canada (BOC) left rates unchanged, again, as I suspected they would. But there was mention of something that could really be a lift for the Canadian dollar/loonie. (CAD) First, the forecast for Canadian GPD was revised upward to 2.4% for 2012, from 2%.

And then something that slipped through most people’s radar — the BOC said that a “modest withdrawal of stimulus may become appropriate.” Again teasing us with the visions of sugar plums in our heads — no, wait — I mean with the vision of rate hikes in our heads!

The loonie received just a bit of a bias to buy on the comments, but the bias was muted.

I saw a report this morning that the Swiss National Bank (SNB) was in the market “checking rates.” But no sign of intervention yet. For any of you new to class or maybe missed class the dozen times I’ve talked about this, here you go.

The SNB set a floor for its cross to the euro at 1.20. The SNB would love really to have the cross be as weak as 1.35. The markets are testing the SNB’s resolve by pushing the euro/franc cross to 1.2015. If the SNB is as tough as they say they are, they will most likely sell francs and buy euros to weaken the cross.

“Checking rates” can mean two things: 1. that the SNB is just trying to see if they can get the markets to move without them really having to do so (a form of jawboning) or 2. this is the first step of intervention. This would ready the markets so they could get all their trading partners lined up for a round of intervention, for if a central bank were going to intervene, they had better come in with both guns a-blazin’! Then it would be the markets’ turn to see if they want to make the SNB eat crow.

But maybe we should just check with the former SNB governor’s wife. She probably has her trades all lined up to take advantage of any SNB action. HA!

The Indian central bank (RBI) did cut rates, surprisingly, yesterday, their first cut in a few years. I have to say I’m confused — no wait, maybe it’s the RBI that’s confused. They said that inflation was 9.47%, but they were cutting their interest rates. They also raised their forecast for next year’s GDP to 6.9%. So let me get this straight: Inflation is running near 10% and a rate cut is going to fuel GDP growth? I used to like the rupee (INR), but this kind of central bank operations just gives me a rash!

It’s been awhile since I’ve talked about the Brazilian real. (BRL) For now, the government and central’s banks actions to weaken the currency are holding, and the real is much weaker. I can tell you by the news stories that I read about Brazil that the central bank has become a real mess, and that’s due to the government sticking their hands in the cookie jar and acting like they knew what to do. Will the markets come back at the central bank this time, like they have so many times before? Right now it doesn’t look like they will, that they’ve grown tired of this game with the central bank.

From well-respected analyst, Barry Ritholtz: “Don’t look to D.C. — the political debates there are laughable. It’s like watching two different Tyrannosaurus rexes debating who gets to eat the dead plant-eater unaware of the giant asteroid hurtling their way. Their argument gets resolved when the asteroid turns their summer into nuclear winter.”

This is a good look back at one of the main reasons the housing market bubble existed and then burst: 45% of the first-time home buyers in 2006 purchased their home with NO MONEY DOWN.

The March budget deficit, as reported here last week, was $198 billion, but did you know that March’s deficit extended a streak that I can’t believe is happening: 42 consecutive months of budget deficits. That’s an all-time record, folks… that’s 3½ years! OMG! And our leaders — I don’t care what side of the aisle they sit on — think they should be re-elected?

And in an exercise of the pot calling the kettle black, it is thought that at the upcoming G-20 meeting in Washington, D.C., that the U.S. plans to press eurozone finance leaders for economic reform. Anyone else see this as strange?

And finally, the data cupboard. Yesterday, capacity utilization edged up 0.1%. Nothing to crow about. And industrial production was flat for the second consecutive month. Housing starts were down by a large margin, but building permits were up. Strange data all the time in housing. No data today.

Then from the Global Times… and you can add this to the list of things that China’s doing to remove the dollar as the reserve currency: “China’s banks will be permitted to hold overnight positions in the renminbi/yuan, a move that also allows them to ‘short sell dollars.’”

Previously, banks were forbidden from short selling dollars, and that’s not good for the dollar, considering how the Chinese hold the dollar in such high praise. NOT! The most important thing though, to me, is that this tells me that China as a country is getting comfortable with the markets moving the currency. You have to remember that in 2005, when the peg to the dollar was removed, the calls for a 40%, 50% and even higher revaluation in the renminbi were very strong.

So the Chinese had to put the shackles on the renminbi. And now, nearly seven years later (where did those seven years go?), the Chinese are beginning to loosen the shackles. It’s all baby steps toward currency domination, folks. I don’t like it any more than you do, but at least I tell you about it, and not sugarcoat what’s going on here to make the Chinese want to do this.

To recap: The currency rally was halted overnight, after a very nice two-day performance. Debt loads in the eurozone are probably to blame for the euro backing off its high yesterday of 1.3175. The Bank of Canada and Sweden’s Riksbank both left rates unchanged, but sounded positive about each respective economy, thus keeping the markets a bit interested in the currencies. The RBI cut Indian rates in the face of inflation that’s running nearly 10%.

Chuck Butler
for The Daily Reckoning