Euro pressured by Greece talks

Outlook:

Data today includes the Case-Shiller home price index, expected to be up 4.5% y/y in the Nov-Jan period. We also get Conference Board consumer confidence. As usual, payrolls on Friday is the Biggie, and this time it has the peculiar effect of coming on the start of two religious holidays, Good Friday for Easter, and Passover. Some markets in Europe will be closed both Friday and Monday, although not London, but even so, we should probably expect a thinner market all around. Market News notes that the holidays, plus the Japanese year-end, might have inspired some to close their books early.

Payrolls are estimated by Market News at a median 250,000 from a range of 195,000 to 272,000, with the rate holding steady at 5.5% and average hourly earnings up a measly 0.2%.

The euro’s failure to thrive yesterday could just as easily have gone the other way. We don’t know what triggered the euro’s drop—expectations of robust growth in the US is what the WSJ suggests. But while growth differentials are a long-term factor and we see correlation of currencies with growth over long periods of time, it’s hardly ever an immediate factor on a day-to-day basis. Besides, Europe and especially Germany has its own green shoots.

How about Greece? Well, it weighs on the euro, but the absence of fresh news implies it’s not Greece dragging the euro down, either. The press generally and especially the FT have article after article on how, exactly, Grexit is probably going to work. The sad truth is that nobody really knows. We are opting for capital controls and selective default, with maybe a bridge loan from Russia in there somewhere. We can bet the Greek leaders will not go quietly into the night.

That pretty much leaves the core concept of diverging monetary policy, which does suffice. The 10-year spread may be relatively stable at 174 points today, advantage US, but the fact remains that the return is higher in the US in absolute as well as relative terms. The ECB commitment to keep rates low to end-2016 while the Fed will be hiking from mid-year to Q3 this year means a widening gap. No matter how the Fed postpones and delays and warns about possible retreat, if you want a real and a nominal positive return, you must leave the euro.

This is the reasoning put forth by major big bank economists, including Barclays, which says “After plunging 23% in 10 months, the question of how much further EURUSD can drop has moved to the fore…We now expect EURUSD to fall to parity by Q3 15 and to 0.95 by end Q1 16.” Market News quotes Barclays at some length: “In particular, as long as the ECB is committed to highly elastic provision of liquidity, the EURUSD will struggle to find its footing and risks come primarily from the US economy. In our view, a stabilization or turn in the EUR will require a sustained and convincing pickup in real investment or acceleration in core inflation that all into question the ECB’s commitments. Neither appears on offer anytime soon.”

So there you have it in a nutshell. Note that Barclays says the “risks come primarily from the US economy.” It’s ours to lose. This is perspicacious. We could get some Washington nitwits trying to push the US into default. The US could get into a ground war in the Middle East. We could have an environmental crisis of some kind—California could fall into the sea or Wyoming’s mega volcano could blow. We could have another 9/11 act of terrorism. Something could happen in oil that disrupts prices in a destabilizing way—like allowing crude exports and refiners run short, pushing gasoline to $5.00. The fixed in-come crowd could be upset and rattled by the arrival of the actual first hike and its inevitable consequence of the Fed halting reinvestment. A sudden loss of demand always lowers the price, right? And in fixed income, a drop in price means a rise in yields.

Vice Chairman Fischer mentioned his own worry—shadow banks could screw up, and they are even bigger now than the last estimate of financial assets in 2013, $25.2 trillion. Fischer said regulators need to get busy. "Non-bank firms and activities can pose the same key vulnerabilities as banks, including high leverage, excessive maturity transformation, and complexity, all of which can lead to financial in-stability."

Nerves may seem okay but events can frazzle them very quickly. This morning we have the hawkish Richmond Fed Pres Lacker saying "Given what we know today, a strong case can be made that the federal funds rate should be higher than it is now. I expect that, unless incoming economic reports diverge substantially from projections, the case for raising rates will remain strong at the June meeting." Weka data, the dollar and oil are transitory factors. Growth will be 2-2.5% and inflation will eventually rise to the needed 2%. "Raising the funds rate target a notch or two is less like taking away the punch bowl and more like just slowing down the refills. We will still be spiking the punch, just not quite as rapidly as we have been."

Ah, but is anyone really ready for it? It would seem not. That means if we get a hike in June, it will be a Shock. In fact, it will be Shock in September, too. Like Grexit, if the Shock is getting priced in, we could have a perverse response—euro up on Grexit, dollar down on rate hike. In the meanwhile, bet the ranch.