Euro Falls as Greece Pushed Toward IMF

The dollar gained ground across the board as the news hit that the IMF will be brought in to help rescue Greece. The dollar was also helped by data which showed existing housing sales fell by less than expected in February. We will get additional news on the status of the US economy today, with the release of durable goods and new home sales numbers for February. We will get a rate decision by the Norwegian central bank today, which could stoke calls for higher rates here in the US. But the big news overnight is concerning the euro (again!).

The euro (EUR) sold off by a full percentage point versus the US dollar after both Germany and France are reported to have agreed to have the IMF involved in aid to Greece. This is an about face for European leaders who announced last week that they had agreed on a European solution to the Greek crisis. But Germany’s Chancellor Angela Merkel threw a spanner in the works a week ago when she said Germany would not participate in giving Greece financial aid. This threw the euro into crisis mode again, as the ‘agreement’ reached early last week never materialized.

So it was back to the drawing board for European leaders, as they will reconvene in Brussels for a two day summit. The euro seemed to catch a break earlier this week as no news was good news and the euro settled in at the $1.35 level. But a German finance minister told reporters that both Germany and France agreed to back an IMF role in aid for Greece, and the euro slid right through the $1.34 handle to a 10 month low against the dollar overnight. The reason for the quick selloff is a loss of confidence in the euro by currency traders.

I have thought the IMF is best suited to handle aid to Greece all along, but currency traders wanted to see the EU step in and handle the crisis without outside help. Bringing in the IMF has caused many to question the political stability within Europe and undermines the confidence in the euro. Naysayers are again calling for a break up of the euro; but bringing in the IMF will probably stabilize things for Greece. Rating agencies will hold on any more downgrades if the IMF opens their funding to Greece. True, the IMF typically asks for some pretty severe fiscal changes before they hand over the funds, but Greece needs this ‘tough love’.

And bringing in the IMF will allow the rest of Europe to refocus their attention on their own economies, which look as if they are beginning to grow again. German business confidence jumped after falling in the fourth quarter, and a composite index of euro-area purchasing managers rose in March. Europe’s service and manufacturing industries grew at the fastest pace in more than two years in March. The euro-region recovery seems to be back on track after taking a breather in the last quarter of 2009.

The Swiss franc (CHF) turned on a dime yesterday, and fell even more than the euro versus the US dollar. The franc was the worst performer versus the greenback over the past 24 hours, dropping more than 1%. I think currency traders lost their nerve in challenging the SNB to keep the currency from further appreciation, and went ahead and booked recent gains. The Swiss National Bank continues to try and ‘jawbone’ the currency lower with talk of intervention, and it seemed to have worked. But most still believe the Swiss franc will appreciate versus the euro and US dollar. UBS AG recently increased its franc forecasts, predicting the currency will appreciate another 3.5% in three months. Currency traders at BNP Paribas also believe it will rise. “The verbal intervention has limited impact on the franc,” said Ian Stannard of BNP. “With the economic recovery gathering momentum, the trend is for the franc to rise.” The franc will continue to be an attractive alternative to the euro.

Another currency that is attractive versus the euro is the Norwegian krone (NOK). The Norges bank will announce their interest rate decision later this morning, and with their strong economy, there is a chance for an increase. Norway was the first European country to increase rates, moving them higher twice, in 2009. Mike Meyer has done a lot of research on Norway for Chuck’s monthly newsletter, the Review and Focus, so I turned to him for some insight. He doesn’t think we will see an increase today, but we will get a move higher during their May meeting. He says inflation hasn’t showed up in Norway, as recent data shows the core rate of inflation fell to 1.9% in February from 2.3% a month earlier. Policy makers want to keep inflation below 2%, and have shown a tendency to make preemptive moves in order to keep a lid on it.

By year-end, the Norges bank is expected to increase their rates a full percentage point. A strong commodity-based economy will allow them to be more aggressive than the rest of Europe with their interest rates. The Norwegian krone should benefit from their strong stance against inflation, and positive yield differentials. We continue to suggest investors have the Norwegian krone as a core holding in their currency portfolios.

The Canadian dollar (CAD) moved a bit higher yesterday on higher oil prices before slipping again in early European trading. The Canadian dollar’s assault on the $1-mark has been stalled since last week, but may get some help from BOC Governor Mark Carney today. Carney is scheduled to give a press conference today, and many believe that he will use this speech to prepare investors for a move higher in Canadian interest rates.

Retail sales, announced last week, showed a dramatic surge in Canada during the month of January. Another report released yesterday showed the leading indicators in Canada moved up 0.8% for February, topping the 0.7% increase the month before. But the data which may force the BOC’s hand is the inflation numbers which surprised the markets last week. Core inflation in Canada was up 2.1% YOY, half of a percentage point higher than economists had expected. The Canadian economy is picking up steam, showing the fastest growth since 2000 during the last quarter. So if BOC Governor Carney takes the opportunity to prepare the public for higher rates, the Canadian dollar could again make a run at parity versus the greenback.

The New Zealand dollar (NZD) weakened after a government report showed that the fourth quarter current account deficit was wider than economists had expected. The current account balance widened to 3.57 billion and 2.9% of GDP compared with expectations of 1.6 billion and 2% of GDP. But the kiwi will probably get a boost today after fourth quarter GDP is announced and expected to show a 0.8% increase. This would be the fastest growth in two years, and would put pressure on Reserve Bank Governor Alan Bollard to lift interest rates.

New Zealand has been taking a cautious approach to increasing interest rates, which has left it behind the Aussie dollar (AUD) in currency appreciation. But the kiwi may outpace the Aussie dollar as Bollard takes a more aggressive stance on interest rates. With inflation starting to move higher, Bollard may have to play a bit of ‘catch up’ with interest rates, and some now believe we will see a full 200 basis point move before year-end. Currency markets hadn’t priced in this aggressive approach, and the kiwi would outpace their commodity counterparts if the Reserve Bank gets more aggressive.

The kiwi is hot on the heels of the Brazilian real (BRL), which is also benefitting from higher growth. Brazil’s credit growth was the fastest in five months, boosting calls for the central bank to raise rates in April. The real was the only currency that held its ground versus the US dollar yesterday; but it is still down 2.5% versus the US dollar this year. The Brazilian real has sold off this year due to a reversal of ‘carry trades’ and the increase of risk in the markets.

Chris Gaffney
for The Daily Reckoning