Betting Against the Euro Not a Long-Term Trade

The sovereign default fears that gripped the markets earlier this week were all but forgotten over the past 24 hours as German Chancellor Angela Merkel pushed for a rapid rescue of Greece. Merkel has played her cards very well, taking advantage of the Greek crisis whenever possible. She held Germany out of the original rescue package, demanding more IMF involvement and only agreeing to participate after getting her way. During the crisis, she has solidified Germany’s position as the leader of the EU. And while she has not made many friends in the weaker members of the EU, her popularity with Germans has increased.

Merkel has been in the driver seat with regard to the Greek bailout, and seems to be willing to let the currency markets take the euro (EUR) lower, only stepping in with support when it seems the EU could be at risk. The lower euro has helped boost the German economy, as exports continue to increase. German unemployment, reported yesterday, fell at the fastest pace in more than two years; declining by 68,000 workers versus estimates of a 10,000 drop. German manufacturing growth accelerated in April and business confidence jumped to a two-year high according to recent data.

The euro will continue to stay under pressure as the sovereign debt crisis continues, but my feeling is the single currency is here to stay. The euro benefits Germany, so they will continue to support it. Individual members, such as Greece or Portugal, may be forced out, but would that be a bad thing for the euro? No, in fact the euro would be even stronger without these weaker members. I don’t think we are at that point yet, but if and when Greece or Portugal or even Italy is forced out, the euro will continue. And after surviving this test, the euro will be in a better position to challenge the US dollar as the world’s reserve currency.

The news out of Europe wasn’t the only thing driving the markets yesterday. The weekly jobs data released in the US yesterday morning emboldened investors. The headlines touted a rebound in the US labor market, as the weekly jobless claims fell 11,000 from last week’s number. The labor market in the US continues to slowly heal. Earnings reports also helped boost investor’s sentiment with US stocks pushing higher on the day. But the jobs numbers are still high, stubbornly holding above the 400,000 mark. The number of people continuing to receive jobless benefits is still high at 4.65 million.

Today we will get a better reading on the strength of the US recovery with the release of first quarter GDP. Economists are expecting a 3.3% increase after last quarter’s surprisingly strong 5.6% increase. Personal consumption for the first quarter will also be released, and is seen by many as an even more important number. The US economic rebound will be driven, as it always has been, by the consumer. Consumption is predicted to have risen 3.3% over the first quarter, more than double the 1.6% increase we saw last quarter. Finally, we will see the Chicago Purchasing manger’s index along with the U of Michigan Confidence numbers. If the data comes in as expected, the dollar would likely get sold off, as investors will be more confident in the US recovery and look to move more of their money out of ‘safe havens’ and into higher yielding currencies.

Brazil seems to fit the bill for many of these investors. Brazil’s real (BRL) surged to the highest level in three months versus the US dollar yesterday after the central bank moved rates higher. The Brazilian central bank was expected to increase rates by 0.5%, but instead made an aggressive 0.75% increase. Interest rate differentials continue to widen for Brazil versus the US, making the real a favorite for carry trade investors. The central bank made the move in order to combat rising inflation. And the markets don’t expect this to be the last increase, as most economists are now predicting additional moves over the next three meetings. The real is the best performing currency versus the US dollar over the past month, increasing over 3.5%.

While the Brazilian real continues to be one of our favorite currencies, the British pound (GBP) has been one we’ve suggested that investors avoid. The upcoming British elections have weighed on the sterling, with the outcome continuing to be too close to call. But the pound sterling caught a bit of a break overnight and strengthened as a poll showed that the Conservative opposition party candidate won the final debate. The polls still show that the elections will not produce a clear winner, and will likely result in a ‘hung Parliament’. But a stronger showing by the Conservative candidate makes it more likely that a coalition will be able to be made with the smaller Liberal Democrat party, and an agreement on reducing the deficit is more likely. Prime Minister Gordon Brown’s Labor party is less worried about the record deficits, so the latest polls suggesting a win by the Conservatives have helped strengthen the pound. But I would still caution investors about buying into this recent strength. The pound will continue to be very volatile even after the elections, as a coalition government will have to struggle to pass major deficit reductions.

Gold continued to rally, adding another $10 to trade above $1,175 for the first time since the beginning of December of last year. Chuck made some great points about the long term benefit of holding precious metals, and investors seem to finally be seeking a TRUE safe haven in these volatile times. Our newest market safe CD, which is based on the appreciation of gold, silver, and platinum is being very well received. This is a great way for investors to participate in future gains in these metals without any principal risk.

The commodity currencies of Australia (AUD) and New Zealand (NZD) both continued to move higher yesterday. The Aussie is heading for the third straight monthly advance, and the kiwi is going to end April with the biggest month gain since September of ’09. Both currencies are benefiting from positive interest rate differentials, and the expectation of further rate increases by their hawkish central banks. As investors feel more confident about the global economic recovery, they are pushing back into the currencies with the highest yields. With carry trades back on, the Aussie and New Zealand dollars will probably end up being two of the top currencies going forward.

Chris Gaffney
for The Daily Reckoning