Increased Confidence for US Recovery
During the recent recession the US dollar has largely traded on risk appetite and aversion. When the news was bad the dollar usually gained due to its status as a safe haven currency. Recently it appears that the link between the dollar and risk assets such as stocks and commodities is weakening. This will allow the dollar to benefit from favorable US economic data. The weakening of the link between the dollar and risk assets means increased investor confidence in US economic recovery and the perception that the Federal Reserve will be the first to raise rates. During the past year positive US economic data has usually led to dollar selling in favor of riskier assets. Bad economic news has usually prompted investors to seek the safe haven offered by the dollar and the Japanese yen.
Dollar Trading on Fundamentals
The relationship between the dollar and risk is rapidly changing. Last Friday’s US jobs report caused the dollar to gain and speculation that the Fed will raise rates to increase. Marc Chandler of Brown Brothers Harriman stated, “Our hypothesis is that the risk-on/risk-off matrix that seemed to dominate market development during much of the crisis is breaking down,. We suspect it is being replaced by a greater emphasis on country specific macro-economic developments.” Reuters News Agency reported that the correlation between the S&P 500 index and the dollar Index has fallen to zero during the past month and reflects a new dynamic where the dollar can gain independent of changes in risk appetite or aversion.
Euro Sentiment Remains Negative
The change in the dollar’s dynamics is taking place as the Euro Zone suffers from the Greek debt crisis. Although last weekend’s teleconference of EU finance ministers caused a slight euro rally most investors remain euro negative. Japan’s flat economy has pressured the Bank of Japan to keep its loose monetary policies. Phyllis Reed of Kleinwort Benson stated, “We’ve seen the U.S. economy continue to recover and it looks probably the most healthy economy in the developed world and that’s helping to support the dollar. We have problems everywhere else.” Historically the dollar and commodities have a negative relationship and a weak dollar creates demand for dollar denominated assets. For months investors have speculated about a Fed rate hike but the Fed has repeatedly said that rates will remain low for an ‘extended period.’ Many investors believe that if US recovery continues at its present pace the Fed will raise rates sooner than expected. Swiss bank “We’ve seen the U.S. economy continue to recover and it looks probably the most healthy economy in the developed world and that’s helping to support the dollar. We have problems everywhere else,” said in a client note, “The dollar may be in a bit of a holding pattern near-term, not declining materially on increased risk sentiment as better economic data will support a Fed rate hike. And not strengthening materially either until more certainty in the timing of the initial Fed rate hike emerges.”
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Fitch’s Downgrades Greece
The euro fell near an eleven month low against the US dollar last week as increasing yields on Greek debt prompted speculation among investors that Greece may turn to the EU for help or would possibly default. Greece received another blow from Fitch’s ratings agency which downgraded Greece to BBB-, just above ‘junk’ status. Fitch’s outlook for Greece remains negative. The euro trimmed some of last week’s losses after the EU said it stands ready to help the troubled Athens government. Richard Franulovich of Westpac Banking Corp stated, “The market had no confidence in Greece and thought default was imminent.” The premium investors are demanding to purchase Greek 10 year bonds vs. German bunds rose as high as 442 basis points which is the highest level since the euro was launched in 1999. Greek Prime Minister George Papandreou said that borrowing at current rates is unsustainable. Many believe that intervention is unavoidable. UBS AG Chief European Economist Stephane Deo said, “The recent market action means that an external intervention may be unavoidable and could happen very soon as the situation is untenable.”
Long Term Problems For Euro
On Friday European Union officials said they are ready to help Greece if necessary. EU officials in Brussels are sorting out the details of the earlier EU/IMF agreement. Some fear that the possibility of a Greek bailout will cause investors to steer clear of holding the debt of other troubled EU nations which will pressure the euro further. Win Thin of Brown Brothers Harriman & Co stated, “Bailing out Greece would take some near-term pressure off the euro, but longer term it’s not the end of it. One thing we don’t know is the amount of contagion risk. As we’ve seen in emerging-market crises, it rarely stops at one country. There’s Portugal, Spain — all these other countries in the same queue as Greece.”
EU Finance Ministers to Hold Teleconference Sunday
On Sunday Euro zone finance ministers will hold talks to discuss the details of how a safety net for Greece will work. A lack of clarity in the earlier EU/IMF agreement has caused investor uncertainty. Recently Greece’s Prime Minister said the Athens government will use the safety net if necessary. In addition to the finance ministers the European Central Bank and the European Commission will also participate in the talks. Greek Prime Minister George Papandreou was quoted as saying, “The question remains whether this mechanism will convince markets just as a gun on the table. If it does not convince them, it is a mechanism that is there to be used.” The effects of the talks will likely influence Monday’s trading.
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Euro at Two Week Low vs. Dollar
The euro traded near a two week low vs. the dollar even after European Central Bank President Jean- Claude Trichet said that default was “not an issue” for Greece. The euro had made slight gains earlier after Greece reported that the nation’s first quarter deficit fell. Vassili Serebriakov of Wells Fargo & Co. in New York stated, “Comments from Trichet had an impact on the euro. While the situation in Greece is not getting much better, I don’t see much scope for it to get worse. We’re seeing no immediate reasons for a break to the downside.” Trichet said that Greece will not default and will not need aid from the EU. The ECB left rates at 1%. The already troubled euro has been pressured by a news report that said the Athens government wanted to renegotiate last month’s EU IMF agreement.
Bond Spreads Pressure Greece
The Athens government denied the report and Tuesday the spread between Greek and German bonds was in excess of 4%, the largest since the Euro’s launch. Euro sentiment was further damaged after a news report that said that Greek banks have asked permission to access funds from a Greek aid package agreed to in 2008. Stuart Bennett of Credit Agricole said, “Renewed uncertainty over Greece is hurting an already jittery euro. Even though the market is already heavily short of euro, there is still downside risk.”Greek debt concerns and concerns that the crisis could spread to other EU nations have caused the euro to decline about 10% from January’s high of $1.4582. Also damaging the euro is a dearth of details about last month’s EU IMF agreement. Fitch rating agency senior Greece analyst Chris Pryce said that the Greek government’s only choice is to ask for help. Pryce stated, “Despite everything the EU and the euro zone have done there is still a lack of clarity (and) confusion about what they intend to do, when they intend do it and how much would be involved, It is now up to the Greek government to go publicly to the EU and IMF and ask for the cash and the support.”
Greece Prefers Market Based Solutions
The Athens government has promised to cut Greece’s debt to 8.7% of Gross Domestic Product this year but remains cautious that budget cuts could spark social unrest. Greece has been plagued by strikes, protests and riots since last year. At the present time the Athens government says it prefers to borrow from markets and will use the EU IMF agreement as a last resort. Government spokesman George Petalotis stated, “For the time being it is not necessary to activate the aid mechanism. The EU/IMF safety net is there to guarantee that Greece is not alone.”
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Japanese Investors Seek High Yielding Assets and Currencies
The US dollar has hit a seven month high vs. the Japanese yen after Japanese investors moved funds abroad to higher yielding assets. The dollar also gained against the euro in advance of a US jobs report which is expected to show that US employers added 160,000 jobs in March. Some believe the strong jobs data could prompt the Federal Reserve to raise rates although Fed officials have repeatedly said that rates will remain low for an “extended period.” The US jobs report will be released Friday, April 2nd. Europe and Asia posted strong manufacturing data lifting risk appetite in equity and currency markets. Matthew Strauss of RBC Capital Markets stated, “We had a slew of nice upside surprises from manufacturing data in China, Europe, the UK … so that’s a good start to the month, and if we get a good payrolls number tomorrow, that’s a dollar-positive.”The dollar gained 0.3% against the yen trading at 93.74 yen. The euro slipped 0.2% vs. the dollar to $1.3489.
Euro Pressured Despite EU, IMF Agreement
Concerns about Greece’s debt crisis linger even after last week’s agreement by the EU and the IMF to provide the debt ridden nation with a safety net. The plan has failed to reduce borrowing costs for the Athens government. Increased borrowing costs mean that the EU leaders may have to implement the rescue mechanism the details of which remain unclear. Such a move would force EU leaders to decide what role the International Monetary Fund would play in any Greek aid package. The move would also put German Chancellor Angela Merkel in a difficult political position in Germany where opposition to any taxpayer funded bailout of Greece is widespread. Phyllis Reed of Kleinwort Benson stated, “What they were hoping for was to set up some sort of arrangement that never has to be used. The markets have sniffed that out and it seems like we’re heading back to square one.”
Many Pessimistic About Greece’s Prospects
The rescue mechanism which is a combination of EU and IMF bilateral loans can only be triggered if the Athens government runs out of funding options. Greek Prime Minister George Papandreou must raise about 11.6 billion Euros by May’s end said the agreement was “very satisfying.” Many remain pessimistic about Greece’s prospects. Razeen Sally of the London School of Economics said, “Markets don’t believe that Greece will be able to see things through.” Trading will likely be thin in advance of the weekend Easter holiday.
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