Good day. We made it through another Monday without too much damage in the currency markets. You know things are getting pretty rough in the currency markets when we consider an average drop of just over 1% in the currencies “not too bad.” World Markets investors can’t say they weren’t warned we would see some tough times over the first half of the year (see more on this subject in the “Then there was this” section).
The euro (EUR) continued to drop on Monday, falling to its lowest level in almost four months as more and more people begin to imagine a euro without Greece. The dollar has been the biggest benefactor of the latest eurozone crisis, as investors moved money back into the US Treasury markets. The rush back to safety pushed the yield on the US long bond back below 3%, and the shorter maturities are also lower.
The Greeks are still without a unified government after the biggest anti-bailout party decided against joining the government. It is looking more and more as if the Greeks will be forced back to the polls for another round of voting.
And the Greeks aren’t the only ones heading to the polls. The Irish will vote on a referendum May 31, which asks the public to approve the “EU Stability Treaty.” While a sharp turn to the left in Greece and the return of the Socialist party to the French presidency has sent the euro lower, an Irish rejection of the EU treaty could be the last straw for German-led austerity measures.
On the flip side, the stability pact requires only 12 nations to ratify it, and German Chancellor Angela Merkel seems to be warming to adjustments to the treaty’s stringent fiscal rules. While a Greek exit is still a possibility, Germany could still allow them to stay after loosening the rules on maximum deficits. Many of the countries that use the euro are in better shape than Greece, but still need the ability to stimulate their economies.
All of this will be debated and discussed at the next EU summit meeting on May 23. Francois Hollande will be representing France, but it will be interesting to see if the Greek government gets organized enough to send a representative to the bargaining table.
The euro has settled into a tighter trading pattern overnight, and is actually starting to move higher as I write this morning. A better-than-expected GDP reading showed the German economy avoided “double dipping” into a second recession.
Gross domestic product in the 17-nation euro region came in flat for the first quarter, compared with an expected 0.2% decline. Germany’s economy grew 0.5% during the first quarter, a surprisingly strong number, which offset some of the weaker GDP numbers in the peripheral economies.
The dollar index snapped 11 days of gains overnight, as it weakened slightly ahead of a full morning of data here in the US. We start the morning off with the inflation numbers for April, with CPI predicted to have risen 2.3% versus a year ago, down from a 2.7% rise in March. We will also see the Empire Manufacturing number, advance retail sales, total net TIC flows and business inventories. There will be plenty of data for currency traders to move the markets.
If the data show the US economy is continuing to slide, we could see renewed calls for another round of quantitative easing here in the US. The impact of QE3 (or is it 4?) on the currency markets is tough to predict. More stimulus would probably cause the equity markets here in the US to rally, and would give the dollar a short-term boost.
But ultimately, QE is negative for the dollar, as it pumps more money into the markets, driving interest rates lower and causing inflation risks to rise. With this being an election year, the administration is geared now more than ever on the short term, so if the data show any weakness in the economy, we could see another push for stimulus.
An article appearing in yesterday’s Wall Street Journal online was appropriately titled “Rare Speed Bump in Commodities’ Long Run.” The title caught my eye, as it reflects exactly what I think we are seeing, a short-term pause in what I believe will be a continuation of the long commodity bull market. But in the short term, both oil and gold are being sold off.
Worries about the slowdown in China, combined with questions surrounding the eurozone credit crisis have decreased future demand for commodities. Oil dropped below $94 for a short period yesterday before rallying back later in the day. Gold has also dropped, erasing its gains for the year. I just don’t understand why gold is selling off in the face of such uncertainty. After all, gold is the only “real” currency, so why wouldn’t people be moving into gold as they sell positions in “risk” assets? I guess one answer would be that investors are no longer worried about inflation, and some of these investors had accumulated gold positions as an inflation hedge. Others will point toward central bank selling into the markets, getting value from one of the only assets that has maintained value. Still others will undoubtedly point toward “market manipulation,” but I will stay away from that in today’s Pfennig.
Most of the commodity-based currencies have sold off in tandem with the drop in oil and precious metals. The Australian dollar (AUD) continues to slide lower along with the kiwi (NZD) and South African rand (ZAR). Brazil’s real tumbled and traded above two per dollar for the first time in almost three years after finance minister Guido Mantega said the exchange rate doesn’t worry the government. This only led to further selling of the currency, as traders took Mantega’s words as encouragement to sell the real versus the US dollar. Brazil’s government is using a weaker real and lower interest rates to help stimulate their economy. Investors are expecting another cut to the benchmark interest rate by the end of 2012.
Then, Chuck usually uses this section to share something he has read recently that struck a chord with him. Yesterday, I mentioned Chuck’s predictions regarding the euro volatility during 2012, and a couple of readers asked me where they could read his projections. That got me looking through some of the past editions of Chuck’s Review and Focus, and I came across the following in the Jan. 1, 2012, edition:
“As we turn the calendar to 2012, most of us know all too well that this is the year the Mayans predicted apocalypse. But maybe they just failed to finish the calendar! OK, that was my attempt at humor, which I’m sure will get shot down in a heartbeat by many. 2012 will also be an election year, so maybe the Mayans were onto something. Nevertheless, this is the event, or the run-up to the event, that will put the dollar back to its underlying weak trend. I’ll explain in a minute, but first…
“I do believe that in the first half of 2012, nondollar investors using foreign currencies and precious metals will have to have some thick skin and batten down the hatches. This shouldn’t come as a surprise to you, dear reader, for in October 2011, I wrote that we were approaching a perfect storm for dollar strength, and that we should expect to see a period of dollar strength that could last several months. While that perfect storm hovered over the euro and other currencies, not really taking its wrath out on the nondollar investments, the storm became stronger until it finally unleashed itself on the markets late in 2011.
“So here we are starting 2012, just like we’ve started the past few years, dealing with dollar strength. This happens almost every year, due to renewed forecasts for economic vigor in the US, only to see those forecasts fade away by the time summer comes around. And I do believe this is where we are this year, too.”
Chuck wrote those last few paragraphs over five months ago, but he was pretty right on with his call for dollar strength during the first half of the year. Now we will see what happens from here. Will we see that event which puts the dollar back to its underlying weak trend?
To recap: The euro continued to slide yesterday as a Greek exit from the euro was on the minds of most currency traders. Euro leaders will discuss a possible “growth pact” at their summit on May 23, and Ireland will vote on the “stability pact” at the end of May. Looks like volatility in the euro will continue! We will get a ton of data in the US today. Could it point to QEIII? Commodities sold off, forcing commodity-based currencies lower. And we ended with a look back at Chuck’s thoughts for the first half of 2012.
Chris Gaffneyfor The Daily Reckoning
Chris Gaffney is vice president of EverBank World Markets and the alternate author of the popular Daily Pfenning newsletter. Mr. Gaffney has been involved in the global marketplace since 1987, and is director of sales for EverBank World Markets. The Daily Pfennig is delivered via e-mail to tens of thousands of market watchers globally, providing commentary that allows them to stay on top of economic, currency, and market happenings. He is a Chartered Financial Analyst and holds degrees in accounting and finance from Washington University in St. Louis.
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