Why has the rally in the EUR been so lackluster? Because there are a still
4 3 more hurdles to overcome before we can put the Greek debt crisis behind us.
The Greeks have jumped over 2 hoops on their own with one more expected to be cleared once the Greek implementation vote is completed this afternoon.
1. Win no Confidence Vote
2. Get Parliament to Approve Austerity Plan
3. Get Parliament to Approve Implementation Procedure
4. Get EU/IMF to Release Next Tranche of Aid
5. EU/IMF Needs to Come up With a Second Rescue Plan for Greece
6. Rating Agencies need to be convinced that the Rescue Plan does not constitute a default
The Greeks have lived up to their end of the bargain by passing the Austerity Package that the EU and IMF demanded and now the ball is in their court. When European Finance Ministers meet on July 3rd, we expect them approve the next bailout tranche, worth EUR12 billion. They will then start to discuss options to ensure continued financing for Greece. Thankfully, investors are not operating in a vacuum because the bond rollover plan proposed by France has received widespread approval and support by the markets. Getting rating agencies to feel the same way will be the main challenge but crafting the second bailout package will not be easy either because even if there is enough participation in the rollover, Greece will still be asked to find buyers for EUR50 billion worth of state owned assets.
Over the past year, the German-US 10 year yield has been a fantastic leading indicator for the EUR/USD. Following Trichet’s latest comments, the spread has soared which in turn points to further gains in the EUR/USD!
The EUR/USD ripped higher after ECB President Trichet telegraphed a possible rate hike next month. The rise in oil prices has hit a cord with the central bank, prompting them to step on the accelerator and get moving with curbing inflation pressures. Not only did Trichet use the magic words “strong vigilance,” but to remove any uncertainty, he said point blank that “Vigilance means rates may rise next month , increasing rates in April meeting possible.”
Regardless of how much Trichet tried to tone down this comment later on by saying it is not appropriate to expect a “big rate move,” and they are not ready to embark on a “series of rate hikes,” the mere prospect of a rate hike is very positive for the euro. Even if the EUR/USD does not take out 1.40 today, it should just be a matter of time before it does so. Based upon Fed Chairman Ben Bernanke’s comments earlier this week, the U.S. central bank is still straddling the fence in terms of normalizing monetary policy. In contrast, the ECB has sent a very clear signal to the market that rates will increased over the next 1 to 2 months. This dynamic should cause the dollar to continue to underperform against the euro.
The race is now between the ECB and BoE and the way its looking, the ECB could be the next central bank to raise interest rates. The central bank upgraded its inflation forecast for 2011 to 2.0 – 2.6% from 1.3-2.3% forecast in Dec and their 2011 GDP forecast to 1.3-2.1% vs. 0.7-2.1%.
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In the Financial Papers:
Canadian Dollar Skyrockets After Housing Market Numbers and Oil
Geopolitical Tensions Weigh on Euro – Iran tests missiles
Trichet Reminding the Markets that they have no bias > last week’s hike was meant a “signal.” ECB is determined to re-establish inflation target.
Hedge Funds Have Worst First-Half Performance in 18 Years, Dropping 0.75%
Australian consumer confidence hits 16 Yr Lows
Fed Bernanke Ready to Extend Bank Aid
Asian Oil Usage Reined in by Reduced Subsidies and High Prices
Oil Prices Sees Largest One Day Drop Since 1991
We are back to the drawing board with the US dollar. Strong consumer spending and the lowest unemployment rate in 14 years could force the ECB to backtrack on their words and actually prepare the market up for more than one rate hike in the third quarter. The June consumer price index is expected to be at 4% double the ECB’s 2% inflation forecast.
Up until now the ECB has openly hinted that a rate hike in July will one-off, but with inflation pressures continuing to increase and growth resilient, 2 rate hikes from the ECB this year is more than realistic.
Other than raising rates by 25bp and moving to a neutral stance, which the market has already discounted, there are 2 other options that Trichet may be considering. One would be to gain the upper hand on inflation by hiking rates by 50bp instead of 25. The second would be to raise rates by 25bp and leave the door open for another rate hike this year. Closing the door completely could be mistake especially as oil prices heads towards $150 a barrel.
As for the US dollar, we are back to the drawing board. The greenback is declining against the Japanese Yen, Euro and British pound. Fears of trouble in banking sector including a profit warning from UBS and talk of a bargain basement sale of Lehman Brothers has stocks set to open lower. The greater the decline in stocks, the lower the chance of a rate hike by the Federal Reserve in the third quarter and the bigger the reason sell the US dollar ahead of the ECB meeting.