ECB Bond Buying Already Priced into the Euro

The euro (EUR) moved off of its recent highs yesterday in advance of tomorrow’s ECB meeting. ECB President Mario Draghi is expected to announce another bond buying program after tomorrow’s meeting in an effort to stabilize the euro debt markets. Unlike his counterpart here in the US, Draghi has been ‘telegraphing’ his next move so the markets have all but priced in the additional stimulus. Draghi has whipped up the markets with his announcements of another round of bond buying, and many now feel the program may fail to do as much as has been promised. Yesterday President Draghi stated the ECB would be buying bonds with maturities out to 3 years, another verification that another round of bond buying is a sure bet.

But the euro definitely looks like it is getting ahead of itself as there are still a number of questions hanging over it. Germany’s constitutional court is scheduled to rule on the legality of the euro region’s permanent bailout fund next Wednesday. The European Stability Mechanism was set up to replace the ‘temporary’ European Financial Stability Facility and was funded with 700 billion euros to help rescue faltering European economies. But there were some questions raised concerning whether or not the establishment of the ESM and the fiscal pact that gives EU institutions powers to enforce budget rules violate the German constitution. Most experts don’t expect the court to find against the ESM, but the ruling will probably include additional language which could put any future or additional European financial integration at risk. While the court ruling won’t shut down the ESM, it will highlight the fact that German citizens and the German courts will continue to have a say in how the EU spends the German taxpayers’ money.

There are also some questions on whether the ECB will lower its benchmark rate at tomorrow’s meeting. According to a survey by Bloomberg, economists are predicting a 25 basis point cut, sending Europe’s benchmark rate down to 0.5%. The rate cut calls have been bolstered by recent data released in Europe including yesterday’s report that euro-area retail sales fell 0.2% in July. A separate report showed the European Purchasing Managers index for services dropped to 47.2 in August, down from 47.9 the month prior. Another report released last week showed euro-area unemployment rose to a record during July. The jobless rate in the euro-area during July was 11.3%, and June’s figure was revised higher to align with July’s number. This is the highest unemployment rate since they started measuring the euro-combined data back in 1995. This poor economic data would certainly seem to support further rate cuts, but can a 25 basis point cut really do much when rates are already at historic lows? I sure don’t think so, and am betting the ECB will just leave rates unchanged while making the announcement of further bond buying.

Currency investors looking for an alternative to the euro have been looking to the north, propelling Sweden’s krona (SEK) over 7% higher versus the US doller in the past 3 months. And unlike other countries who are battling against their currency’s appreciation, Swedish leaders have told their manufacturers to get used to a stronger krona. In an interview yesterday, Swedish Prime Minister Fredrik Reinfeldt said the strong krona is here to stay. “The strong krona is not a short-term phenomenon, it’s something we should get used to,” Reinfeldt said Monday. “What is needed now is to invest to make Swedish industry more efficient and the labor force more skilled.” I like his attitude! We need more leaders like Reinfeldt. Instead of intervening to try and drive the value of the currency lower to drive exports, he is advocating that his citizens be proud of their strong currency. “A strong currency scenario is something that we have been working toward by cutting our debt and deficit levels,” Reinfeldt said. “Given that Europe is in the grip of a debt crisis, whereas we have been cutting debt, it’s not really surprising that the krona is appreciating.” Well said!

His words should inspire investors to continue to look at the Swedish krona as an alternative to the euro. But the officials at Sweden’s Riksbank don’t all agree with the Prime Minister. Policy makers in Sweden meet today and will publish their rate decision tomorrow morning. Expectations are for no change in the interest rates in Sweden, but there has been pressure from the trade unions and export industries for a lower rate in order to try and stem some of the recent appreciation of the Swedish krona. But Riksbank Governor Stefan Ingves has pushed back, saying the bank shouldn’t use monetary policy to try and steer the krona. I would expect them to leave rates unchanged.

Data released here in the US yesterday showed manufacturing shrank for a third month in August which equates to the longest decline in US manufacturing since the recession ended in 2009. The ISM factory index fell to 49.6 last month from 49.8 in July. As with most of these indexes, a reading below 50 indicates a contraction. Digging into the data, both orders and production dropped to three-year lows.

But the declines in manufacturing may not continue as vehicle sales rose more than analysts had expected. Chrysler had the largest increase of 14% while Ford and GM’s sales climbed 10%. Total vehicle sales increased to 14.46 million during August vs. just over 14 million sales in July. Increases in domestic vehicle sales drove the total increase, with truck sales improving dramatically. Demand for full-size pickups jumped 16% and is a good indication that the US economy, and the housing market in particular, may be turning a corner.

Pickup trucks have been the bread and butter of the US auto industry, and sales dropped dramatically with the US housing downturn. The jump in the number of pickups being purchased during August is another indication that construction workers are beginning to feel more confident. New home sales rose 3.6% in July and sales have rose over 25% in the past 12 months. While the housing market still has a way to fully recover, the recent improvement has helped drive new truck sales. Ideally, the additional truck sales leads to an increase in manufacturing which then leads to additional housing starts and the cycle begins again with additional truck sales. In reality it certainly isn’t that simple, and I feel the housing market definitely has another couple of years of ‘recovery’ before we get back to pre-crisis levels. But it is nice to see things moving in the right direction.

The Australian dollar (AUD) touched the lowest level in more than seven weeks as 2nd quarter growth slowed more than forecast. Australia’s GDP rose 0.6% in the second quarter which was slightly lower than economists’ expectations of a 0.7% gain. First quarter GDP in Australia was a revised 1.4% according to the report released yesterday. From a year earlier, the Australian economy expanded 3.7% which is the strongest annual pace since 2007. While growth has slowed, the rates are still very respectable and Australian interest rates remain among the highest of all industrialized nations.

In spite of these positives, the Aussie dollar remains in a declining technical pattern, and certainly looks like it is on its way to parity versus the US dollar. This may have been one of the reasons the RBA decided to leave rates unchanged over the weekend, knowing the lower currency prices would have a stimulative effect on this export-driven economy. I still feel the Aussie dollar will have some value at parity, and don’t expect the currency to breach that level.

Gold traded off its recent highs yesterday, unable to breach the $1,700 level. Silver was also down a bit, but it certainly deserved a rest after shooting up over 17.6% during the month of August. There are several factors which are pushing the precious metals higher, including the some technical factors which were pointed out by one of our long-time friends.

Adrian Day has been a friend of EverBank since our founding, and appears at many of the conferences which we attend throughout the year. I ran across a story on Bloomberg which had a quote from Adrian regarding the recent rise in prices of metals. According to Adrian, gold prices may rally to $1,900 an ounce by March 31 as increasing expectations of global stimulus measures boosts the metal’s appeal as a hedge against inflation. Workers at Adrian Day Asset Management compiled a chart which showed investors are increasing their gold holdings at the fastest pace in six months.

Bill Gross over at PIMCO agrees with Adrian’s views and posted a ‘tweet’ yesterday which said the ECB stimulus plan would be ‘very reflationary’ and means that investors should buy gold.

To recap. Draghi is expected to announce another round of bond buying tomorrow, but the markets have already priced this into the euro. Sweden’s prime minister has told his manufacturers to get used to a stronger currency. US data indicate the housing market may be rebounding as truck sales have increased. The Aussie dollar remains in a declining technical pattern and should bottom around parity. And finally our friend Adrian Day expects gold to reach $1,900.

Chris Gaffney
for The Daily Reckoning