Greek and Italian Turmoil Negatively Affect the Euro

Right off the bat, this is going to be super short and sweet this morning as Chuck was feeling under the weather last night and asked me to step in with some of the market headlines from this morning and last night. The market moving headlines yesterday and through today so far have been primarily European in nature, as Italy is beginning to steal the spotlight away from Greece in the debt crisis du jour. Since Italy is a bigger fish in the Eurozone than Greece, the levels of concern have been on the rise.

All of this turmoil has caused the euro to drop about 2 cents so far this morning and is now just trying to hold onto the 1.36 handle. The markets have been so very fickle over the past couple of months that things could easily turn on a dime in US trading if there are any positive comments or developments that come out of Europe as the day progresses. We saw this happen yesterday as the markets were pleased with the decision from the Italian Prime Minister, Silvio Berlusconi, to step down.

His decision wasn’t necessarily of his own will, but instead, it seems that pressure from the markets had backed him into a corner and forced his hand. He was also on the receiving end of a strong round of criticism, both internally and externally, so the calls for his resignation have grown louder and louder. Italian borrowing costs have risen sharply over the past several days as the interest rates on bonds have risen to the highest level since joining the euro (EUR).

The currency market has, in turn, marked the euro down quite a bit this morning since the Italian economy can be thrown in the too big to bail out category as they don’t see a clear plan for appropriate austerity measures. The rising yields have cast fears with investors that Italy won’t have the ability to meet the interest obligations, and therefore, need some type of bailout or a default would result. Austerity measures are currently the topic of discussion for Italian politics, so I’m sure there won’t be a shortage of things to talk about.

Moving over to the United States, it’s going to be another quiet day as we only have the weekly gauge of mortgage applications and the measure of September inventories to contend with, so not much to speak of today. We’ll see data tomorrow that will actually have some teeth with the September trade balance and the October budget statement, although the markets are all but comfortable with these disappointing figures. We’ll also see if the weekly jobs numbers can remain south of that stubborn number of 400K or if this was just a temporary jump.

With the euro down about 1.5% this morning, all of the other currencies, except for the yen (JPY), are showing up in the red column. We have the Swedish krona (SEK), Norwegian krone (NOK), and South African rand (ZAR) bringing up the rear this morning. Since the euro pretty much sets the direction for most of the other European currencies, Sweden and Norway have been pushed down even though they aren’t a part of what’s wrong in Europe. Since a majority of their trade is within the European Union, they get punished as if they were a part of the euro and are labeled as such. I wouldn’t say that its justified, but it’s just market perception and eventually fundamentals will prevail.

This is definitely a risk-off type of day, so most of the financial markets find themselves in the red at this point. The high yielders, commodities, and stock futures are all off so far on thoughts global growth will wane and a European spawned credit freeze could ensue. As we have seen for the better part of this year, the markets take a statement or a situation and interpret it to one extreme or the other. In other words, one positive data report means the US economy is in the clear or as we see today, a roadblock or challenge in the Eurozone gets interpreted as a death blow for the currency and world economy.

Chris Gaffney sent me some thoughts to include, so here you go:

China’s efforts to tap the brakes seems to be working. Consumer inflation rose at an annual rate of just 5.5% in October, the smallest monthly increase in almost three years. A 5.5% inflation rate would certainly be of concern here in the US and in Europe, but China continues to have near double digit economic growth, so higher inflation would be expected. The government’s efforts to slow the Chinese economy were a source of a lot of market angst in the last several quarters, as many believed they would not be able to control price increases without forcing their economy into an abrupt slowdown. But this latest inflation reading indicates the government has been able to cool the price increases without halting economic growth. Chinese officials have also been helped out by the continued problems in Europe and the US, which have helped keep a lid on commodity prices.

These lower commodity prices have put pressure on the commodity currencies of Australia (AUD) and New Zealand (NZD). The Aussie dollar continued its decline yesterday, and has fallen almost 3% versus the US dollar during the first 9 days of November. China’s demand for Australia’s raw materials is likely to continue to fall in the near term which will continue to weigh on the value of the Aussie dollar.

But the declines in Aussie dollar and New Zealand dollar will probably be limited by the higher returns these countries offer. Even after the recent rate decrease, both Australia and New Zealand continue to offer investors a nice yield advantage over the currencies of Europe and the US dollar. These rate differentials should put a ‘floor’ under these two currencies, and limit the damage to investors’ currency portfolios.

Then there was this… All of the bad news flowing out of Europe lately has helped divert our attention away from just how bad things continue to be right here in the US, but a story appearing on CNBC’s website yesterday paints an ugly picture of the US housing market. The title says it all: “Half of US Mortgages are Effectively Underwater”. “Home prices continue to fall as a glut of bank-owned homes and lack of job growth continue to hold down the US housing market. The story states that 28.6 percent of the mortgages on single family homes are currently underwater. That equates to 14.6 million borrowers.”

But the story points out that many other homeowners have so little equity built up in their home that they don’t have the financial ability to move (no money for a down payment or moving expenses). Adding these homeowners into the calculation brings the total households ‘effectively’ underwater to over 50%. Not good news for anyone hoping a housing turn-around will help pull the US economy out of our current funk.

Thanks Chris for the fodder. So on that note, I’ll go ahead and wrap this up for today.

Mike Meyer
for The Daily Reckoning

The Daily Reckoning