Is Angela Merkel the Most Influential Leader in the EU?

We had another strong day for the dollar yesterday, with the greenback gaining against all of the majors. But overnight, the Asians and then the Europeans sold the dollar and moved money back into the currencies. So after another rollercoaster ride, we are basically right back where we were at this time yesterday morning. These volatile markets are likely to continue, as investors try to figure out if the global economy will recover or if we will slide back into recession. With all of this uncertainty, you would think investors would be moving into ‘hard assets’: gold and silver. But the markets for these two precious metals have been surprisingly quiet this year. More on the metals a bit later, first I will try to figure out these currency markets.

The dollar moved higher yesterday after the durable goods data showed a third straight monthly increase. Orders rose 0.5% in February after a blistering 3.9% rise in January. Ex-transportation the orders were up even more, showing a 0.9% increase. These numbers were better than expected, and got economists talking about an early rise in US interest rates. Manufacturing continues to pull the US economy along, as companies restock inventory to meet an improving global demand.

But the housing data, released an hour and a half later wasn’t so rosy. New home sales failed to climb to economists’ projections, and fell to a record low of just 308,000 in February. This was a 2.2% year-on-year drop and followed an 8.7% drop in January. But the markets weren’t going to let the poor housing data stand in the way of a dollar rally, and we continued to see dollar strength throughout the trading day. The dollar index even moved above 82 for the first time since May of last year. But the dollar couldn’t hold its strength in the Asian markets, and the Europeans have sold it off even further this morning.

European leaders begin a two-day summit today in Brussels, and the Greek crisis will be their focus. It has been interesting to watch how the EU has dealt with this crisis, and events have proven who is the real leader of the EU. German Chancellor Angela Merkel has emerged as the most influential leader in the EU. Last week it seemed an agreement had been reached, as it was announced the EU countries would back financial assistance to cash-strapped Greece. But Merkel said NEIN! She was not going to participate in a Greek bailout, and instead encouraged them to turn to the IMF for support. The markets took the euro (EUR) lower after her refusal to go along with the program.

But now French President Nicolas Sarkozy has indicated he supports Merkel’s plan. With the two big dogs of the EU singing from the same sheet of music, a Greek bailout by the EU is all but dead. Greece will have to turn to the IMF for funding, if and when it is needed. But right now, as Merkel has continued to point out, Greece has not asked for any financial support. I would expect the EU to make a statement of support for Greece, but leave any financial support to the IMF. This should be an acceptable plan for all parties, Greece will receive their support, and the EU will not be on the hook for future bailouts of the PIIGS.

And another bailout may be needed sooner rather than later. Fitch ratings agency downgraded the debt of Portugal yesterday, contributing to the euro’s sell off yesterday. The news pushed the euro to below $1.33 before it moved back up this morning. The downgrade reminds everyone that Greece is not alone in their debt problems. It also reminded me of something that I meant to bring you late last week. Chuck had struggled with a name for the US states that are in need of a ‘bailout’, and several readers came up with the same acronym: MANIC (California, New York, Illinois, Michigan, & Arizona) and one other suggested replacing Michigan with Pennsylvania and changing it to PANIC. Funny stuff! I realize this is some serious stuff, but you have to insert a bit of humor or else the dire situation could become unbearable! But back to Europe…

So Merkel is probably going to end up getting her way. Ty Keough pointed out a story to me yesterday which backs my assertion last week that Merkel may have an alternative motive for deep-sixing the EU led bailout. A weaker euro is absolutely in the best interest of Germany, which is an export driven economy. While everyone is beating up China for manipulating their currency, could Merkel be doing the same thing? Recent data shows the German manufacturing sector is expanding at the fastest pace in nearly 15 years, and export orders are also expanding at record speed. The drop in the value of the euro, combined with rising demand has helped accelerate the German recovery. I picture Merkel doing her best imitation George Peppard from the A-Team saying, “I love it when a plan comes together” (thanks to Aaron for that reference).

I mentioned the other day that US debt is now trading at higher prices than the debt of some blue chip corporations. This is unusual, and could be a scary sign of things to come; investors now have less faith in the US government debt than the debt of Berkshire Hathaway. Another story in the WSJ caught my eye this morning. Credit Default Swaps – (the derivative insurance policies that helped bring down AIG) now show that US debt is riskier than that of the Eurozone. According to the story “…a lot of market participants would see this as a bit of a shot across the bow, a bit of a wakeup” for anyone who’s complacent about the US debt. With all of the attention focused on the European debt crisis, many have taken their eye off of the problems right here in the US. But with rising debt levels, and waning confidence in the ability for the US to meet our commitments, the US could be in store for their own credit shock. The debt rating agencies have to be watching this closely, and could move to put the US on a ‘credit watch’.”

Norway left rates unchanged, and the krone (NOK) took a hit because of the non-move. Investors had positioned themselves for a bit of a surprise move by the Norges bank, and when the higher rates didn’t materialize, the krone got sold. But higher rates will come, and Norway continues to have one of the strongest economies in all of Europe. Investors should take advantage of these prices to add to positions in the krone.

China continues to let investors know it won’t be folding to external pressures to let the renminbi (CNY) appreciate. Vice Minister of Commerce Zhong Shan said, “The Chinese government will not succumb to foreign pressure to adjust our exchange rate,” during a trip to Washington to meet with lawmakers. “To force the appreciation of the renminbi will be counterproductive.” Several lawmakers have proposed retaliatory tariffs for Chinese goods, sparking talk of a trade war. The Treasury Department is ‘seriously considering’ labeling China a currency manipulator in an April 15 report which would make it easier for companies to seek import duties according to Senator Charles Schumer. But China would likely dig in their heels if Schumer and his colleagues were successful according to those who know and understand the Chinese leadership. “You can kiss goodbye any notion of China letting the currency to begin to float upward, once it is labeled a currency manipulator,” one Chinese expert was quoted in a report.

The New Zealand economy grew at the fastest pace in two years in the fourth quarter as reported overnight. GDP in New Zealand rose 0.8% from the previous three months as consumer spending, manufacturing, and housing all saw increases. Growth will probably accelerate this year, forcing Reserve Bank Governor Alan Bollard to raise interest rates. Higher rates should help support the kiwi (NZD), as interest rate differentials attract investors. All good news for the New Zealand dollar.

Gold gained a bit yesterday as investors took advantage of low prices. The recent dollar strength has beaten down the price of gold to levels we haven’t seen in a month. All of the uncertainty in the markets has increased demand for a stable asset, and gold certainly fits the bill. There is a risk that all of the monetary stimulus measures will remain longer than necessary, and force global inflation rates higher. Gold is an excellent hedge against higher inflation, and prices are relatively low. Investors began moving back into gold to take advantage of these low prices, which I think is a smart move.

The only data due to be released this morning is the weekly jobs numbers, which aren’t expected to show any real change in the employment picture. Looks like it will be a ‘wait and see’ kind of trading day, as the markets focus on tomorrow’s fourth quarter GDP numbers.

Chris Gaffney
for The Daily Reckoning