Risk Returns, Dollar Buying Ends

Well, the “is this Greece’s Lehman Brothers moment” talk has subsided, this morning, as today Greece votes on the austerity measures in the budget… As I’ve said now for the third day in a row, the real stickiness comes tomorrow, when they vote to “implement” the measures…

I do believe that both votes will be positive, but not without a few fingernails chewed, while pacing back and forth in a worrisome state. If both votes pass, then Greece will receive the next tranche of their original bailout package, which was due to be paid to them next month, which is very quickly coming at us like a freight train! In two days, we’ll be to July… So, this vote is what you would say “in the nick of time”…

The markets are generally on board with what I just told you, regarding the outcome of the votes, and have begun to reverse the dollar buying we saw at the end of last week… Currencies are generally better off this morning than they were on Monday morning, with the euro (EUR) leading the way. Gold actually found a bid yesterday, and the gold price found its way back above $1,500… But that’s to be expected, given the reversal of the dollar buying going on.

The protesters in Greece are none-too-happy about the possible outcome of the two votes, today and tomorrow… I know that the measures hurt… But isn’t it better to hurt a little now, than to get to your retirement and find that there’s nothing there? No money? No benefits? Nothing, absolutely nothing! Say it again! The Greek protesters are making the cable news, just about every hour, and are in competition with the Casey Anthony case for air time…

And the price of oil also rebounded last night and this morning, moving up $2… So, as you can imagine, or guess, the risk aversion that was ON late last week, and earlier this week, has been transferred to the risk takers, which means the high yielders are doing well, and outperforming all other currencies this morning.

And the 200 lb gorilla in the corner (China), is coming out of the corner to let everyone know that they believe in the Eurozone, and the euro, and will continue to support them. Following up on his comments earlier this week, Chinese Premier, Wen Jiabao, (Wen) said that, “The difficulties that have appeared in Europe are temporary. As long as financial reforms and adjustments continue, the difficulties can be gradually overcome. At Europe’s time of difficulty, we reached out a helping hand. We expressed confidence in Europe’s economy and confidence in the euro. We have also said that we will buy a certain amount of sovereign debt from some countries, according to needs.”

Well… As long as he’s not blowing smoke in our faces… That’s the kind of stuff that helps a region like the Eurozone… And its currency, the euro…

Ok… I saw something yesterday that made me just stop, and begin writing about it, for it so angered me, that the only way I could keep my blood pressure from soaring was to pound on the keyboard… So, here are my thoughts, as I pounded on the keys yesterday….

It’s The Only Game in Town…

No… My beloved Cardinals aren’t in town… And I’m not talking about the Ringling Bros. traveling circus, or Cirque du Soleil! I’m talking about our beloved Federal Reserve, maintaining their Treasury buying, even with the so-called end of QE2… The economy, as I’ve been telling you for months now, is not self-sustaining at this point… And I feel that the US economy has taken a page out of the Japanese economy’s book on “how to become addicted to government stimulus”… So… Enter the Fed Reserve, which at this point is scheduled to buy at least $300 billion worth of Treasuries in the next year… It’s the only game in town, folks… Without them buying, the Treasury market would be a mess!

I had a reader send me a note on this yesterday, and the note said that we can call this QE2.5! Another customer sent a note and said that we should have a contest to see who can come up with the most creative name for the Fed’s Bond Buying program, the artist formerly known as “quantitative easing”… But quite frankly, I can barely keep up with the emails I receive now, so, I’ll pass on holding that contest… But it does bring to mind the thought that this will continue to be the only game in town for some time… And if Japan is any indication – which I do believe it is, and have been telling you so for a long time – then we could be doing the do-se-do with the Fed buying Treasuries to stimulate the economy and ballooning their balance sheet for a loooonnnggg time! OH! And before anyone thinks I made this $300 billion number up… It was reported on CNN.com, which is where I read it, and began to feel my blood pressure rise…

It’s like the Fed is singing along to the song that’s playing on my iPod right now… “Hard Habit To Break”! (One of my all-time fave Chicago songs)…

A piece of data that just came across the screens shows that Canadian inflation is soaring… (They apparently don’t have hedonic adjustments to keep inflation in line!) Canadian CPI (consumer inflation) rose 3.7% in May versus May 2010… So that’s another item to put on the side of the ledger that’s keeping track of the reasons to hike or not hike rates… This news has the Canadian dollar/loonie (CAD) pushing higher versus the green/peachback this morning.

And… Yesterday’s data showed us that home prices continue to fall… The S&P/CaseShiller Home Price Index printed a -3.96% drop in prices from a year earlier… Not the -4% that was thought would print, and I heard some talking heads on the cable news saying that the number was so much better… Come on! Get a grip! 3.96% is so darn close to 4% that rounding would probably put us at 4%! Geez Louise! And in a surprising data print… Consumer confidence fell this month… As it should, but usually doesn’t go along with my thoughts on confidence…

OK… So… The euro is back to 1.44 as I write, and the Aussie dollar (AUD) is back to $1.06… The Swiss franc (CHF), which I told you yesterday would clear the $1.20 hurdle, did just that and is $1.2025 this morning… So, you get a flavor of what I said at the top regarding the dollar-buying ending, for now… I say “for now” because there’s no way that the Eurozone is out of the woods, just because Greece ends up kicking the can down the road… So, we could continue to see these bouts of dollar buying as we head to the dog days of summer, but only until the markets see what I said above, that the US economy is not self-sustaining at this point, and their knee-jerk reaction to this will be to scream for more stimulus…

There were two things going on with Greece, folks… You had the next payment of their bailout being held hostage until the austerity measures could be put in place, and… You have the ongoing bond maturities that need to get paid… And here’s where, as I’ve said for a few months now, with most of the Greek debt held by Eurozone banks, the banks could agree to extend or “rollover” these maturities to longer dated bonds, thus pushing off the problems of paying the bonds now… Maybe if the Greeks actually implement and carry through with the austerity measures, then by the time the bonds need to be paid, or the interest needs to be paid, Greece’s balance sheet looks a lot healthier… Maybe…

Then here in the US we have the same problems… No, no one is holding back a bailout payment to us… What I’m talking about is the debt in this country… You know, the people and government officials in Greece didn’t think they had a debt problem, until they did… And that’s the same here… And I still believe that within a month we could be watching another financial calamity here in the US. Sure the Fed is going to keep buying $300 billion of Treasuries next year, but that would only cover three auctions… The budget deficit will be $1 trillion, you can count on that…

And this could be what triggers that financial calamity… Here in the US, the number of banks below regulatory capital levels has increased to 175, and that was at the end of the first quarter! At the end of the first quarter of 2007, there were only 7 that failed to meet this criteria. When this happens, bank examiners are required to take prompt corrective action to resolve the problem. The FDIC’s balance sheet has turned red to the tune of $50.7 billion…

I don’t like having to talk about that stuff, because I work in a bank… But I don’t worry about our bank… I even get upset when people blame bankers for the economy’s problems… And I really don’t like it when the say “fat bankers”… Hey! I take offense at that! (Ok, if you’ve never met me face to face, you won’t get that joke!

Then there was this… I saw a piece on TV yesterday talking about lending activity, or better, the lack of lending activity…

The people were discussing their reasons for the lack of lending activity…

I can tell you this… It’s a serious case of “damned if you do, and damned if you don’t”…

Banks and lending institutions were damned for lending to people who had no ability to repay their loans, and that blew up in their faces… And banks and lending institutions were damned for not lending to people who have no ability to repay their loans… And unfortunately, this too will blow up in their faces…

And it’s just like everything we see in life… Something goes along until there’s a problem, and the correction takes the problem 180 degrees the other way, until the correction seems to be completely wrong too!

But it goes deeper than that, folks… I can tell you from personal experience that having an excellent credit score, more than enough money in the bank, and making a sizeable down payment, I was put through the ringer, not once, not twice, but at least three times… If I had known I would have to go through the ringer once, I would have just walked away… Banks, for the most part, are trying to clean up their balance sheets, just like consumers… So for now, lending activity is not going to be the stuff that strong economies are built on… And there will not be any “velocity of money”…

To recap… The currency mini-rally has turned to an all-out rally, with dollar buying that began late last week ended. The risk aversion people have gone back to their caves, and the risk takers are giddy about the prospects of two positive votes from Greece… Of course, there’s risk in doing that, but that’s not the worry right now… Oil and gold rebounded, as dollar weakness became the order of the day… The Fed is going to continue to buy Treasuries next year according to CNN.com, and China’s Premier talks up the Eurozone and the euro…

Chuck Butler
for The Daily Reckoning

The Daily Reckoning