Trichet Gives the Euro Some Support

The euro (EUR) remained well bid yesterday, rising above $1.27 for the first time since May, after European Central Bank (ECB) President, Trichet, had some encouraging words for the Eurozone. Trichet said that he didn’t believe that the things were as bad in Europe as the markets have made them out to be. The ECB President made his remarks at a press conference after the ECB left its benchmark rate at a record low of 1%.

In addition to stating the eurozone is in no danger of falling into a ‘double-dip’ recession, Trichet suggested the ECB will continue to wind down the ‘quantitative easing’ program they undertook to help the region pull through the Greek crisis. The program, which began in May, involved purchases of European government debt by the central bank. These programs were used extensively by Japan, UK and the US to pump money into their economies during the financial crisis; and the ECB followed suit in order to help the European banks during the debt crisis. Notice that I said the programs were used to help the European banks, not the European economies! The buying of government debt by the ECB was, in my opinion, solely designed to stop the losses the major European banks were accumulating on the bonds which they were holding.

Quantitative easing is by far the most inflationary thing a central bank can do, as it equates to throwing the printing presses into overdrive. So it will come as no surprise that the program was vehemently opposed by Germany’s central bank. The Bundesbank’s Chief Axel Weber has been a vocal opponent of Trichet’s decision to institute quantitative easing, and will continue to pressure Trichet to make a quick exit from the bond purchases.

Before heading out the door last night, Chuck had this to say about Trichet’s comments on the strength of the European economy:

“I think this is very important, folks, because…you would have to think that the ECB has a handle on what’s going on in the Eurozone banks, or else he wouldn’t make a statement like that to end up with egg on his face. Of course we’ll actually see the results of the bank stress tests on July 24th… If those tests would happen to come back without any major surprises, then I would think the euro could add further to its gains. I’m told that there’s a line of resistance at 1.2730, and should the euro surpass that figure it could be establishing a new upward trend, that wouldn’t be predicated on short covering trades!”

I overheard Chuck tell a Wall Street Journal reporter yesterday, that he believes the euro’s move has been a combination of 1. Short covering trades, and 2. An overall better feeling about what’s going on in the Eurozone. Whatever the reason, the euro has put together a good little rally over the past month, moving from a low of $1.18 on June 7th to move above $1.27 yesterday. As Chuck suggested, if the bank stress tests come back positive, the euro could see further strengthening.

Another currency which has had a great week versus the greenback is the Aussie dollar (AUD), which is headed for the biggest weekly gain in nine months. The Aussie dollar was the best performing currency during the trading day yesterday, as investors were encouraged by the positive employment report released yesterday. Australia now has more people in paid employment than at any other time in its history. Good news out of China and India (two of Australia’s largest trading partners) also contributed to the rally in the Australian dollar.

Our friends over at Goldman Sachs believe the Australian dollar has even more room to run. Goldman analysts wrote a note to clients yesterday suggesting investors should buy the Aussie dollar, targeting a gain of over 5% in the near term.

The Canadian dollar (CAD) also had a good day yesterday, rallying for a third day in a row and reaching the highest level in a week versus the US dollar. And a further rally can be expected today, as the jobs number came in almost five times higher than what economists had expected. Employment in Canada rose by 93,200 in June, following gains of 24,700 in May. While the June figure wasn’t a record (that was set in April with a 108,700 job increase) it shows how strongly the Canadian economy is recovering. This is great stuff for the loonie, which could make another push toward parity after these strong consecutive monthly jobs numbers.

The long awaited Treasury report on currency manipulators was released yesterday, and to nobody’s surprise it did not declare China as a currency manipulator. The report said China took a ‘significant step’ last month when it ended its recent peg to the US dollar and allowed the markets to push the currency higher. Again, this was widely expected, as Geithner just doesn’t have the cojones to call out China. After all, they are the largest holder of our debt, and we certainly need them to keep buying with all of the new debt auctions we announced yesterday. But it is also well known that China is indeed a currency manipulator, and the announcement last month was nothing more than cover for the US Treasury department to hide behind.

You only need to look at the currency appreciation over the past month to see China is still keeping their currency very closely tied to the US dollar. During the past 30 days the renminbi (CNY) has appreciated 0.84% versus the US dollar, while just about every other currency has had greater appreciation versus the dollar. We will probably see more pressure put on China to allow further appreciation as their trade gap almost doubled last month from a year earlier according to estimates. The data is due out today, and would show a return to sustained trade surplus after a deficit in March.

Chuck mentioned the Singapore dollar (SGD) for the first time in a number of weeks yesterday, and he proved to be a bit clairvoyant, as there were several news stories talking about the Singapore dollar on the wires this morning. A story on Bloomberg suggested Singapore may overtake China as Asia’s fastest growing economy this year. GDP in Singapore will rise to 10.8% in 2010 according to Bloomberg estimates. China is predicted to grow 10.1% in 2010, giving Singapore the title of the fastest growing economy in Asia.

These higher growth rates could lead to higher inflation rates in Singapore, and the government will be monitoring price levels very closely. Unlike most nations, the Singapore central bank doesn’t use interest rates to fight inflation, but instead uses the level of their currency. So if the central bank sees inflation picking up, you can expect them to let the Singapore dollar appreciate. We saw just this scenario play out a few months ago when the central bank let the currency appreciate over 2% in a day in order to combat rising inflation.

No news out in the US today, and yesterday’s news was fairly uneventful. Initial jobless claims continued higher than what the administration would like to see, increasing over 450K. The biggest surprise was the consumer credit number which declined over 9 billion versus an expected decrease of 2.3 billion. And the revision to last month’s numbers came as an even larger surprise. Consumer credit reportedly rose 1 billion during April, but this was revised to show a decline of close to 15 billion yesterday. Talk about a revision!! The Federal Reserve was just 16 billion off in their estimate! The administration would like to see US consumers go back to their ‘borrow and spend’ attitude in order push the US recovery; but this latest data calls a consumer led recovery into question. While a decrease in borrowing by US consumers is exactly what I believe will benefit the US economy in the long run, it certainly puts us at risk of moving back into the second leg of a double dip recession. This isn’t good news for the US dollar in the short-term.

To recap… Trichet suggests the ECB will be exiting the ‘quantitative easing’ program, both the Australian and Canadian dollars rally after very good employment reports, Geithner lets China off the hook regarding currency manipulation, Singapore is set to be the fastest growing economy in Aisa, and US consumers are tightening their grip on their wallets (good for the consumers, but bad for the US economy).

Chris Gaffney
for The Daily Reckoning