Chris Gaffney

The Greek Parliament approved the austerity measures yesterday, giving traders the confidence to head back into the markets. We will have a fairly big week of economic data releases here in the U.S., which should help keep things interesting. Lots to cover, so I better get going if I am going to get this delivered on time!

Friday had most traders heading for the “safety and security” of the U.S. Treasuries, as many were questioning whether or not the Greek prime minister would get the support he needed from his parliament. The euro (EUR) retreated from above 1.32 and most of the other currencies retreated along with the big dog euro. Worries over the European debt crisis also moved the commodity markets lower on Friday, as global growth prospects were clouded by questions in Europe. As I wrote on Friday, the Greeks were basically holding global markets hostage, with investors “hunkering down” in U.S. dollar-denominated investments.

But the Greek Parliament changed everything with a 199-74 vote in favor of the spending cuts the EU, IMF and ECB required as a condition of a second bailout. Now the focus will shift back to these European institutions, which will vote to release the rescue funds at a meeting on Wednesday. So while the vote was certainly needed, we could still see some volatility in the next two days as euro-area finance ministers consider this latest rescue package.

According to Lloyds Banking Group, the euro is set for a nice rally. A currency strategist at Lloyds sent a note to his clients last Friday that pointed to a record number of short positions in the euro futures markets as a reason for the euro to climb to $1.36 in the near term. As most Pfennig readers probably know, a short position in the futures market is a bet that a currency’s price will fall. But when these short positions are at or near record levels, they put tremendous pressure on a currency to reverse course. With record short positions, news that starts the currency in a different direction can ignite a ‘short covering’ rally that gains momentum as investors race each other to buy the currency in order to “cover their shorts.” Momentum builds much like a snowball rolling downhill, sending the price of the currency higher. The strategist from Lloyds is certainly looking good this morning, but we will have to see if the Greek vote ignites the short covering rally he wrote about.

I, for one, hope the EU/IMF bailout for Greece is successful, if for no other reason than I am absolutely sick of reading and writing about the Greeks. I would love to move past the eurozone crisis and move on to more “normal” markets. While the euro has had some fairly wild gyrations lately, the crisis has actually kept the overall currency markets fairly calm. Implied volatility for the G-7 currencies has dropped to the lowest level since August 2008, according to JP Morgan.

Lower volatility in the currency markets will favor our old friend the “carry trade.” Investors in the carry trade borrow funds in lower-yielding currencies such as the U.S. dollar, euro or Japanese yen (JPY) and then convert them into higher-yielding ones like the Aussie dollar (AUD), Indian rupee (INR), South African rand (ZAR) or Brazilian real (BRL). As long as the currency markets remain fairly stable, these investors can pocket the yield differential or “carry” on these trades. This was, by far, the most popular currency strategy of the past decade, but faded with the onset of the European debt crisis.

Investors at EverBank World Markets can take advantage of the return of the carry trade by taking positions in these higher-yielding currencies. The Brazilian real is the highest-yielding currency we offer, with a 5.09% annual percentage yield on a three-month CD, and the South African rand is second, with a 3.55% APY on a 3-month CD. Of course, these higher-yielding currencies are also usually some of the most volatile, so investors could see some wild swings in value. For example, investors in the South African rand lost over 15% last year, and investors buying the Brazilian real also had double-digit losses.

The return of the carry trade is actually a good sign for the markets. Investors need confidence in the global outlook in order to make bets that rely on fairly stable markets. But a piece of data released last Friday indicates U.S. consumers are feeling overly confident yet. The University of Michigan confidence reading for February fell more than expected, from 75 down to 72.5. This was much greater than the expected move down to a 74.8 reading. The increase in gasoline prices and a stubbornly slow increase in the labor market has kept a lid on U.S. consumer sentiment.

Fed Chairman Ben Bernanke blamed the housing market for preventing the central bank’s efforts to spur economic growth from taking hold. Bernanke would like to see Congress take further steps to help the housing market. “We have helped lower mortgage rates to the lowest point in many, many decades,” Bernanke told homebuilders Friday in Orlando, Fla. “Yet we are not seeing as much activity as we would like to see.” The Fed chairman was in Orlando last Friday, and so was Chuck. Maybe Bernanke should have gone over to the MoneyShow to listen to Chuck’s ideas on how to get things moving in the right direction!

We don’t have any data coming out in the U.S. this morning, but the rest of the week will be pretty busy. Tomorrow will bring us the retail sales numbers along with the business inventories and import price index. Wednesday will be the volatile Empire Manufacturing numbers, along with the MBA mortgage apps and TIC flows. We will also get one of Chuck’s favorite economic indicators on Wednesday, capacity utilization, along with the minutes of the last FOMC meeting. Thursday is always the day we get the weekly jobs numbers, but they may be overshadowed by the other data, including the PPI, housing starts, building permits, mortgage delinquencies and the Philadelphia Fed index. Friday will bring us the CPI numbers for January, along with leading indicators. As I said, Chuck will have plenty of data to write about this week.

The confidence generated by the positive Greek vote has spilled over to the commodity markets. Hedge funds have increased bets on rising commodity prices to the highest levels since September. The recent good news on the U.S. labor market has helped turn investor sentiment positive, as the U.S. economy seems to be holding its grip on recovery.

With commodity prices rising, the commodity currencies of South Africa, Norway (NOK), Canada (CAD), Australia and Brazil all moved higher. South Africa’s currency rallied almost 1% vs. the U.S. dollar and tied the South African rand as the top performers over the past 24 hours. Brazil’s consumer prices rose in January for a third consecutive month as the economy continued to accelerate. The rise of 0.56% was in line with the median estimates, and annual inflation slowed to 6.22%, according to reports on Friday. As I mentioned last week, Brazil will probably start looking for new ways to bring inflation levels down to their target rate of 4.5%, and currency appreciation is certainly one tool they could use.

Australian Treasurer Wayne Swan is sounding a cautious tone after the RBA lowered its 2012 growth forecast last week. While he expects Australia to expect “solid growth,” tame global growth and recent gains in the Aussie dollar will limit the pace of growth Down Under. But data released Friday suggest the Australian economy will be able to maintain “solid growth.” Australian home loan approvals jumped in December by the most in seven months and exceeded economist’s forecasts. The RBA lowered rates in November and December of last year, helping to spur the housing market. As I said earlier, a return of the carry trade would be a big positive for the Aussie dollar, as it is a favored investment of Japanese investors, who are some of the largest carry trade investors.

The Norwegian krone has also put together a nice rally over the past week, long overdue, in my opinion.

Then there was this. Did everyone see the 60 Minutes piece on India and their obsession with gold? I have long believed one of the main reasons gold will stay on an upward trend is the continued demand out of India. The Indian economy has been second only to the Chinese with regard to growth rates, and this impressive growth has generated additional disposable income for a vast number of Indians. As 60 Minutes pointed out, gold is the favored investment for most Indians. Weddings are big over in India, and in one wedding on the show last night, the bride and groom’s parents spent over $200,000 on gold. While this looked to be at the higher end of wedding celebrations, the news program pointed out that even lower-income families spend what we in the West would believe is an outrageous amount on gold for the celebration. The gold is seen as both a dowry for the bride and a show of stature by both families.

The use of precious metals as an investment option is popular throughout Asia, but none of these countries can compare to India. And with growth in India predicted to remain robust, the additional disposable income generated should prove to keep a floor on the price of gold, and, in my opinion, could lead to further price increases in the coming years.

To recap: The Greek parliament approved the austerity measures, rallying the euro, which dragged most of the other currencies with it. Lloyds thinks we will see a “short covering rally” in the euro, which could move as high as $1.36. The carry trade is returning, and should bring the high-yielding currencies back into vogue. Commodity prices rebounded, pushing the rand, NZD, AUD and even the NOK higher. And 60 Minutes says Indian growth should support the price of gold.

Chris Gaffney
for The Daily Reckoning

Chris Gaffney

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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