The Greeks are Given Another 15 Days to Find More Cuts

As Chuck wrote yesterday, the markets were feeling confident that an agreement on a second financing accord for Greece was going to be finalized yesterday. The euro (EUR) continued to rally on the news through most of the day, but the talks stumbled over the issue of pension cuts, and EU/IMF officials had to give Greece 15 more days to come up with additional cuts. The delay in an agreement caused the euro to retreat from the two-month highs against the dollar, moving back into the $1.32 handle after trading as high as $1.3313. But there is still confidence an agreement will be met, as the parties have agreed on all the issues except a 300 million euro reduction in pension benefits.

The ECB meets today to set monetary policy, and ECB President Mario Draghi will hold a press conference following the meeting, so we could see some additional euro volatility throughout the trading day. Draghi will definitely be questioned on the ECB’s possible role in securing a second round of funding for Greece. The ECB reluctantly entered the debt markets, purchasing bonds in order to keep rates from rising too dramatically. They have accumulated a substantial position in Greek debt, and the IMF wants them to agree to take a write-down on this debt in order to reduce Greek debt levels. The bonds purchased by the ECB were already at a discount, but Greece wants them to take an even larger discount on these holdings. The bonds bought by the ECB in its Securities Market Program are exempt from the current debt-swap deal, but Greece needs additional debt reductions, and the IMF is pressuring the ECB to write down this debt.

It will be interesting to see what Draghi decides to do, as many of his cohorts in the ECB aren’t interested in booking big losses on this debt. And if the ECB is forced to participate in the Greek debt write-downs, what will that mean for the other distressed debt that the ECB has purchased? It would certainly seem to set a precedent that the ECB would have to follow in dealing with other debt purchased through their QE efforts of the past year.

The data released this morning in Europe will give the ECB a bit of good news to start their meeting. Economic confidence in the euro area rose in the first quarter after posting losses in the previous two. The positive move was led by an improvement of expectations for the euro region over the next six months, according to the Ifo research institute, with the indicator measuring future expectations rising from 57.4 to 70.5. This is still under its long-term average, but a good move in the right direction. ECB President Draghi has said 2012 will be a “much better” year and, these data indicate many of the business leaders seem to agree.

The Bank of England will be meeting also, and many expect BOE Gov. Mervyn King to announce additional stimulus measures. Economists predict King will announce an increase of 50 billion pounds to their target for bond purchases, and some expect an even larger 75 billion pound increase. Growth in the U.K. has resumed (albeit very slowly) following a contraction in the last quarter of 2011. But King has indicated he would like to see stronger numbers, and doesn’t seem to be worried about any inflationary impact of pumping additional funds into the U.K. economy. The risk of slipping back into a second recession seems to far outweigh any future negative impacts of additional stimulus measures in the mind of the current BOE leader. With rates near zero, additional bond purchases is the preferred policy tool of the BOE, and an increase is being priced in by the markets.

At least one Federal Reserve president here in the U.S. would also like to see additional bond purchases. John Williams, the Fed president of San Francisco, said he thinks there is room for additional purchases of mortgage-backed securities by the Fed. “There’s only so much headroom to do further Treasury securities of a medium- or long-term duration. But there is more room out there in the mortgage-backed securities space,” Williams told reporters in California. Fed chairman Ben Bernanke said yesterday that he sees a “long way to go” before the job market returns to normal, and additional bond buying is one option that is still on the table. It makes me a bit nervous to be following in the footsteps of the BOE and BOJ in what seems like another round of QE.

No data releases in the U.S. yesterday, but today is Thursday, which means we will get the weekly jobs numbers. Initial jobless claims are expected to have increased to 370,000 from 367,000 last week, and continuing claims are expected to have risen to 3.5 million. This data may seem counter to last week’s unexpected drop in the jobless rate to a three-year low, but the reason for this drop in the big number is that workers are simply giving up looking for work. So while last week’s announcement of a drop in the unemployment rate to 8.3% sent stocks soaring, the rate doesn’t give the true picture of the U.S. labor market. Chairman Bernanke pointed this out in his speech to the Senate Budget Committee yesterday, saying the job market remains a “long way” from returning to normal.

China’s inflation unexpectedly moved higher in January, according to reports released yesterday. Consumer prices rose 4.5% from a year earlier, a number that was higher than every economist’s predictions. The rise in prices was partially due to a weeklong holiday in January, which increased the number of shopping days available for consumers to make purchases. The higher inflation rate reduces the possibility of further policy easing in the near term, but most economists are expecting inflation to cool in the coming months.

The hike in consumer prices in China is yet another indication that the Chinese economy is not headed for a meltdown. This is good news for the commodity-based currencies of the New Zealand (NZD) and Australian dollars (AUD), and both hit near-term highs yesterday. The Kiwi traded back above 84 cents for the first time since September of last year. A report released in New Zealand showed employment grew last month, albeit at a slower rate than expected. New Zealand employment rose 0.1% in January versus a median forecast growth of 0.4%.

The Aussie dollar’s recent moonshot stalled a bit yesterday, as the Greek negotiations stumbled. The AUD$ has been on a two-month move higher, vaulting from below 97 cents at the end of November to a high of 1.0845 yesterday. The Reserve Bank’s move to keep interest rates unchanged, and their positive outlook on global growth prospects, has given investors confidence in the Australian dollar.

The guys who read the technical charts say the Aussie dollar looks overvalued at the current levels and suggest waiting to see a pull back to $1.05 before making any additional purchases. Another story I read on Bloomberg suggests the Aussie’s recent rally will force the Reserve Bank to resume cutting interest rates as higher Aussie dollar prices will negatively impact Australian exports. I guess it is just additional proof that you can spin things any way you want. I still feel the commodity currencies are the place to invest.

Then there was this… On my drive to work this morning, I heard a newscaster saying how it was nice to see Congress finally coming together to pass an important piece of legislation. I wondered could it be real deficit reduction? Tax reform? Tort reform? No, it was the bill that would ban members of Congress from profiting from using inside information in trading stocks. Shouldn’t this be illegal already? In fact, it is, as members of Congress are not exempt from existing insider trading laws, but the Constitution’s protection of their “speech or debate” makes it extremely hard to investigate violations. A 60 Minutes report back in November showed some members of Congress, including House Speaker John Boehner and Minority Leader Nancy Pelosi, had bought stock in companies while legislation that might affect those businesses was being debated. I guess it is good news that they are finally doing something about the loophole, but wouldn’t their ethics already prevent this? Oh, I forgot, I am talking about Congress.

To recap. The Greek leaders have been given 15 days to find additional cuts to offset pension costs. The ECB and BOE meet and both may be adding to their bond buying. The ECB has to decide if they want to take a haircut on their Greek debt. Chinese inflation pushed higher, causing a rally to the commodity currencies. And our Congress is set to pass a law which really shouldn’t be necessary.

Mike just pointed out a headline that the Greek parliament has come to an agreement on additional cuts which should seal the deal on a second round of funding. This should send the euro and the risk currencies higher today!

Chris Gaffney
for The Daily Reckoning