"Risk Off" Currencies Rally on Greek Credit Downgrade

We had a busy but manageable day on the trading desk yesterday, which was all we could ask for with both Chuck and Aaron traveling to Las Vegas and with me tied up in meetings all day. The newest member of our WorldMarkets family, Antione, spent his first full day on the phones, and did quite well according to the rest of the gang.

We were helped a bit on the volume of calls by a relatively calm trading day, which was welcome following the volatility of last week. The euro (EUR) started off yesterday morning with a bit of a boost provided by the good economic data out of Germany, but S&P threw a spanner in the works with another downgrade to a Eurozone member. Greece has been in the news lately, with a leaked story in Der Spiegel and a new agreement by the EU to restructure the bailout. S&P (as usual) jumped in the mix a bit late with another cut to Greece’s credit rating. The news ended any hopes of a rally for the euro, which settled in a trading range around $1.4350.

S&Ps chopped Greece’s credit rating two notches, and the move scared many investors out of ‘riskier’ investments. So it turned out to be a ‘risk off’ day in the currency markets. As I walked out the door last night, the worst performing currencies were the high yielding Brazilian real (BRL) and South African rand (ZAR). The best performing currency versus the US dollar continued to be the Nordic currencies of Norway (NOK) and Sweden (SEK).

This was the second trading day in which these two currencies shined. The reasons are fairly simple; both countries have very strong economic fundamentals and central banks that are looking to raise interest rates. With all of the worries over a possible breakup of the euro, investors have moved money north into these relatively stable economies. Of course, last night’s move, which took oil back above $100 a barrel, helped, as Norway is a major exporter of North Sea crude. Norway’s currency was also helped by data released this morning which showed that underlying inflation quickened to a 1.3% annual pace in April, up from a 0.8% increase in the previous month. The inflation data indicates the central bank will probably look to raise rates sooner rather than later.

The quantitative easing policies of Japan and the US have heightened investors’ concerns regarding inflation, and ‘smart’ money is moving into currencies that have solid economic fundamentals and central banks which are positioning their economies to combat rising prices. Personally I feel the recent rally in both the Norwegian krone and Swedish krona are a bit overdue. We have been encouraging investors to use the Norwegian currency in particular as part of a ‘base’ to their currency portfolios.

I had several readers point out something I had missed regarding the jobs numbers on Friday. McDonald’s hired 62,000 workers during an April 19th national hiring day. So when you add the 62,000 McJobs to the 175K ghost jobs, you start to see just how the Labor Department was able to report a 244K increase. No wonder Chuck’s predictions were off a bit; the game is rigged! McDonald’s wouldn’t specify just how many of these jobs are minimum wage, but I would guarantee most of those hired aren’t going to be able to support a family on the wages. I’m don’t mean to be negative about those who work at McDonald’s, as it is an excellent training ground for those just entering the labor market. But these jobs can hardly be seen as a long-term boost for our economy. Again, the important number is the 9% unemployment rate that continues to climb in spite of everything the administration tells us. Thanks to the several readers who alerted me to the McJobs data.

This morning, as I turned on the trading screens, a reversal occurred, and traders had begun to bring risk back to the table. The higher yielding currencies rallied back and the ‘safe haven’ currency of the Swiss franc (CHF) gave back some of its gains from the day before. The Brazilian real has made back all of its losses, and the euro is right back where it was trading yesterday before the S&P announcement. A Greek paper countered yesterday’s Der Spiegel story with one of their own that announced a second bailout had been agreed to by Eurozone officials. The apparent agreement will cover Greece’s projected need for another 27 billion euros in 2012 and 32 billion in 2013. It also involves the extension of existing maturities on existing bailout loans and a lowering of the interest rate on these loans. This news was the main driver of the reversal of the risk aversion, which we had seen creeping back into the market.

I read a research report by David Bloom – a currency strategist in London with HSBC – which agreed with much of what we have been writing in the Pfennig. Bloom said the dollar would remain weak until there is a change in the perceptions of US monetary and fiscal policies. “Concerns over US fiscal sustainability have combined with low interest rate expectations and constrained market volatility to keep the dollar on a downward trend,” Bloom wrote. “The dollar is undoubtedly ‘cheap’, but, other than shorter term recoveries based on position adjustment, it is difficult to see the dollar enjoying a sustained recovery.”

I agree with much of what Bloom wrote, but the change needed isn’t in just the perception of US policy, but in the policies themselves! I also think the dollar is far from cheap, but agree with Bloom that the dollar will continue on its downward spiral.

With another reprieve of the euro crisis and the announcement that China booked a record trade surplus, commodities jumped back on the rally train. China reported a trade surplus that was more than three times larger than forecast in April. The strength of the Chinese economy was a big reason investors were willing to move back into commodities, reversing the recent slide in the price of oil, copper, silver, and gold.

The jump in crude oil helped rally the Canadian dollar (CAD), Mexican peso (MXN), and as I mentioned earlier, the Norwegian krone. Canada is the largest exporter of crude oil to the US, so the price move back above $100 certainly helped boost the loonie. But Canada is more than just a commodity currency. Canadian banks are some of the strongest in the world, and Canada’s fiscal policies place it in a much better position than the US. Finally, Prime Minister Stephen Harper’s election victory last week indicates that Canadians are behind his deficit cutting plans. Things are looking good for the Canadian currency.

But a couple of commodity currencies couldn’t join the rally train. The South African rand and New Zealand dollar (NZD) were both left behind overnight. New Zealand’s dollar fell after the IMF said the currency is 20% overvalued relative to the equilibrium exchange rate. I will have to do a bit of research on just what they mean by the equilibrium exchange rate, but I’m pretty sure it will have something to do with purchasing power. The kiwi also got sold after the Treasury Department said New Zealand’s budget deficit was wider than expected in the nine months through March.

The South African rand stayed lower after rumors ran through trading desks that the South African Reserve Bank was buying dollars to keep the rand down. The Reserve Bank had scaled back its foreign currency purchases during April, but apparently they were back at it yesterday, selling rand and buying US dollars in order to keep the value of the rand down.

To recap: S&P downgraded Greece’s debt, which took the euro lower, but a second bailout package enabled the euro to erase the losses. Thanks to readers who alerted me to the McJobs, which made up a majority of the new private sector jobs in April. Norway’s krone jumped higher and deservedly so! HSBC sees a steady decline in the dollar, and China announced a record trade surplus. Commodities rallied but NZD and ZAR were left off the rally train.

Chris Gaffney

for The Daily Reckoning