Greek Debt Won't Kill the Euro

The euro (EUR) moved back above the $1.40 handle overnight after it was announced the EU would back Greece’s plans to cut its budget deficit. European Commission President Jose Barroso said the EU is endorsing the Greek program and relayed confidence in the Greek authorities. The move came after the Greek government announced more measures to reduce the shortfall. The EU will demand monthly updates from Greece on its progress in cutting their deficit from the current 12.7% of GDP down to the EU’s 3% limit by 2012. The approval of the plan by the EU does not mean the union will be backing Greek debt with loans and does not insure against a default, but only allows Greece to continue to be part of the EU despite their large deficits.

The news seems to have calmed some of the speculators who were predicting a break-up of the euro. But many still believe Greece will need financial support by EU members in order to pull themselves out of the debt hole they have dug. One of my favorite economists, Nouriel Roubini, believes the EU or ECB will likely step in with loans or guarantees in order to quash the attacks of speculators on the euro. “I expect there is going to be eventually some financial support,” Roubini said on Bloomberg TV yesterday. He also suggested Greece should be going to the IMF to get a package of support.

Nobel laureate Joseph Stiglitz was also in the press yesterday suggesting that the EU should back Greece with financial support to end attacks on the euro. “If it made an announcement of support, then the hedge funds and speculators going after the euro would lose hope and they would just go away.” But the ECB seems to have drawn a line in the sand, and does not want to open the door for other week members of the EU to come to them for support. The IMF seems to be the best bet, but Greek Prime Minister George Papandreou has avoided going the IMF, and has instead pledged to freeze state wages and announced increases in a fuel tax. For now, the markets seem to be willing to give Greece some time to see if these measures can work.

The other big news out of Europe will come later this morning, as the Norges bank will be announcing their latest rate decision. Everyone, including Chuck and I, believe they will keep rates steady, but they have surprised the markets in the past. The Norges bank was the first in Europe to raise interest rates back in October and increased them again at the end of the quarter. Norway’s economy is doing well, and a recent jump in home prices gives them reason to come back to the rate table. But with the Greek situation keeping the value of the euro down, they fear a big jump in the value of the krone if they do surprise the markets with a rate increase. Currency traders will be analyzing the statement that usually accompanies their rate decision, to see how soon we should expect another move up. Hopefully I will have the rate decision by the time I get this done, and will include it in my wrap-up. No matter what the Norges bank does today, they continue to maintain a hawkish stance, and their economy continues to be strong; both of which should keep the Norwegian krone (NOK) underpinned.

The pound sterling (GBP) moved higher versus both the euro and the US dollar after data showed that UK consumer confidence rose in January. The reading of 73 was nearly double the 39 measured one year ago. As Chuck pointed out earlier this year, Britain returned to growth in the fourth quarter, ending a long recession. But like the US recovery, the UK recovery is still questionable. The BOE has said they would announce a pause in their quantitative easing program later this week after spending 200 billion pounds on emergency bond purchases. Like the US’s Fed, the BOE has pumped billions of pounds into the markets in order to try and stimulate them, but the inflationary impact of these moves has yet to be felt. I believe these quantitative easing policies were reckless, and applaud their end.

But without government support, the bond markets will be a bit thinner, and interest rates will likely be bid up putting the fragile recoveries in the UK and US at risk. And with both countries heading toward elections later this year, will the central banks be able to fight off political calls for additional stimulus measures? I doubt it! I expect both to come back to get another hit of the ‘stimulus drug’ which will only add to their deficits, and make the job of kicking the stimulus habit even harder down the road. The longer we remain on the easy money path, the harder we will be hit by the inflation train that is coming down the tracks. This isn’t good news for the US dollar or the pound sterling.

But back to what is happening today. The dollar drifted lower overnight as investor confidence continued to strengthen and they moved funds back into riskier assets and away from the ‘safe haven’ of the dollar. Data released yesterday morning in the US showed December pending home sales moved up 1% after falling 16% in November. Compared with a year earlier, pending sales rose 10.5%, with the $8,000 government incentive for first time homebuyers being credited for driving many of these sales. Today we will get the Challenger Job data and ADP employment numbers, along with the ISM non-manufacturing number. The employment numbers are expected to be disappointing, but many are expecting to see a slight increase in the ISM number.

Tomorrow will be a much bigger data day, as we will get the weekly jobs data along with the factory orders and nonfarm productivity numbers. And the week will close out with another big round of data with the first monthly jobs numbers for 2010. The recent dollar strength could turn on a dime if this data shows a big jump in the unemployment sector and a decrease in factory orders. Investors have begun to buy back into the ‘feel good’ story of a US economy that is well on its way to recovery. These numbers could give the markets a cold slap of reality, bringing risk aversion back into vogue.

But for now, investors are looking for yield, and the benefactors yesterday were the South African rand (ZAR) and the Brazilian real (BRL), both of which posted nice gains overnight. Brazil’s SWF was not in the market, and the real was allowed to appreciate over 1% versus the US dollar. The real was helped by the announcement that industrial output had a record gain in December from a year earlier. Brazilian industrial production jumped 18.9% in December after having contracted 14.7% a year ago.

As I am wrapping this up, the dollar is moving dramatically higher, but I can’t figure out what is driving it higher. The numbers released are right in line with expectations. I’ll have to try and figure out what is going on and will give Chuck my analysis to include with tomorrow’s Pfennig.