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May 8th, 2010 @ 3:45 pm by Matt "NewstraderFX" Carniol

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*And Maybe For Paper Currency

The New Your Times published a very interesting chart the other day which outlines how deeply in debt the PIIGS (Portugal, Italy, Ireland, Greece and Spain) are: $3.889 trillion or 4.958 trillion euros at Friday’s exchange rate. Of that amount, $2.053 trillion or 2.617 trillion euros, is owed to Germany, France and Britain (or presumably, their commercial banks).

Meanwhile, the absurdity of the Greek “rescue” package will only serve to put the nation further into debt both in absolute terms and in percentage terms of its GDP.  As of 2009, Greece’s GDP was about $345 billion, which means its debt-to-GDP percentage was 68.4%. But with $136 billion of new debt (the EU-IMF rescue package) and with Greek GDP estimated to fall about 4% in 2010, the percentage of debt-to-GDP rises to over 112%.

In other words what we have here is round 2 of the debt crisis, which is defined as “which banks are exposed and by how much.” Round 1, as you’re probably aware of, occurred in September 2008 after Lehman Bros. was allowed to collapse. At that time, as now, no one knew exactly which banks were exposed or by how much (although it was generally known that the exposure was huge). As a result of the uncertainty, inter-bank lending rates (LIBOR) soared as banks refused to lend to each other, which naturally caused financial markets to freeze.

We’re already seeing the beginnings of this same scenario happen right now. On Friday, 3 month LIBOR (the cost of borrowing dollars for 3 months) climbed 5.5 basis points to 0.428%, the highest level since Aug. 17, 2009 and the biggest increase since Jan. 16, 2009. It also was the 13th straight gain in this “fear gauge.”

The spread between three-month Libor and the overnight indexed swap rate rose more than 6 basis points to 18.5 basis points, the most since Aug. 26 2009. The measure at one point ballooned to 364 basis points, or 3.64 percentage points, after the Lehman debacle.

According to Simon Johnson, former chief economist at the IMF and co-author of the new book 13 Bankers, the joint EU-IMF program has only a “small chance of preventing an eventual Greek bankruptcy.”

During the negotiations which occurred prior to the announcement of the Greek plan, The IMF floated an alternative scenario with a debt restructuring, but this was rejected by both the European Union and the Greek authorities. This is not a surprise; leading European policy makers are completely unprepared for broader problems that would follow a Greek “restructuring,” because markets would immediately mark down the debt (i.e. increase the yields) for Portugal, Spain, Ireland and even Italy.

The fear and panic in the face of this would be unparalleled: When the Greeks pay only 50% on the face value of their debt, what should investors expect from the Portuguese and Spanish? It all becomes arbitrary, including which countries are dragged down. Adding to the problems are that European structures are completely unsuited to this kind of tough decision-making under pressure.

So, where do you go as a trader? Certainly, in the face of what’s happening you want to be out of anything that looks risky, which means stocks and commodities. The dollar is likely to continue gaining in this situation because there’s no other paper currency which can serve as an alternative. But there is one other “currency” however: Gold.

In “normal” times, gold trends downward as the dollar gains and it rises when the dollar falls, which is what happened once the dollar began depreciating as stocks rose from Mar. 09 2009. But when panic sets in, as it did after Lehman collapsed on Sept. 15, 2008, gold appreciates along with the dollar. For example, from that day until stocks begin rising, gold went from $779 to $929 while EUR/USD went from 1.4242 to 1.2889.

Gold and the euro peaked in early December as traders first began speculating on European problems. But once the market started to better appreciate the full extent of the European debt crisis in early February, gold rose from a low of $1044 to reach $1207 even as EUR/USD fell from 1.3677 to Friday’s close on 1.2750.

I would look for this trend to continue, because what’s going to happen is either one of two things: Debt restructuring or the far more likely debt monetization by the ECB, which means that Europe’s Central bank will be printing a lot more euros in order to buy the debt of the PIIGS.

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May 4th, 2010 @ 11:26 am by Matt "NewstraderFX" Carniol

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The ECB has been running its printing presses overtime, and it now looks like the presses are going to be running 24/7. The debt of Europe is now being monetized, which basically means that if a country can’t pay what it owes-viola! The ECB will just print more.

Europe’s commercial banks have been able to take the Greek bonds it buys to the ECB and swap them for cash that the ECB prints. This is the indirect monetization system-literally the printing of new money to pay old debts. Before, the ECB’s policy was to accept Greek bonds as collateral for cash as long as at least one credit rating agency maintained an investment grade rating on Greece.

Some thought that the ECB would actually toughen their collateral rules in the wake of the debt crisis and make it more difficult (and expensive) for the banks to trade their bonds. But then came last week’s downgrade of Greek government debt to junk status by Standard & Poors. The ECB’s response? It actually relaxed its collateral rules and will now accept Greek debt no matter how low Greece’s credit rating goes.

No one knows exactly how much Greek debt has been bought by Europe’s commercial banks, because the numbers are not made public. Also unknown what would happen with this bond-for-cash- swaps should Greece ever default on its obligations. For example, can the ECB hold the banks accountable and force them to reverse these swaps (i.e. return the cash received from the ECB for Greek debt)?

Of course, the situation goes way beyond Greece because the implication that is that any country (Portugal, Spain, etc.) that finds it too difficult and expensive to sell bonds into the market will also have its debt monetized by the ECB. In other words, the ECB, with its relaxation of collateral rules, has basically announced that it will print as much money as necessary, or, as much as it can before people decide they’ve had enough and abandon the euro altogether.

We’re actually starting to see this already because the euro is declining not only against other paper currencies but against gold as well. In fact, all paper currencies have been, and will continue to, devalue relative gold.

I said last week that the euro is a doomed currency and that I expected to see it decline to the lower 1.20’s as the year progresses. With the ECB now on a dedicated mission to monetize the debt of Europe, what’s likely to happen is that my downward target will need to be adjusted.

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April 25th, 2010 @ 5:14 pm by Matt "NewstraderFX" Carniol

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Despite the fact that financial markets were calmed on Friday, the debt crisis now threatening Europe figures to get worse going forward.

That’s why I prefer to fade the euro rally. Looking at specific levels, there’s initial resistance near $1.3350. A move above there would likely be checked in the $1.3400 and then $1.3450 area. On the downside now, a move back to $1.3250 is possible on any disappointment. Over the medium term, the issues outlined here, within the context of an expanding US economy (estimated to be between 3% and 4% in 2010) will likely push the euro back below $1.30 with a move toward the mid-$1.20s a reasonable target.

The root of this debt crisis, as usual, was that interest rates were kept too low for a borrower who was determined to borrow and spend as much as it could in order to maintain a veneer of prosperity because as an EU member, Greece had access to lower borrowing costs than it otherwise would have. For years, Europe’s Central Bank actually facilitated profligate spending by allowing the commercial banks, which buy the debt, to deposit it at the ECB as collateral for newly printed money.

The bailout money that Greece will receive over the next year from the EU and IMF at relatively low (5%) rates, which amounts to about 18% of GDP or 4000 euros per person, is only a short-term ‘solution’ that actually does nothing to resolve many of the longer term problems that exist. With its total debt at 114% of GDP, nearly twice that of Argentina when it went into default, Greece is economically on the verge of bankruptcy  after years of refinancing its interest payments by issuing new debt on the assumption that economic growth would continue.

The point has now been reached where financial markets are refusing to buy into this Ponzi scheme as evidenced by the recent dramatic rise in the cost of borrowing that’s actually a judgment not on Greece alone, but rather on the entire EU-ECB bailout system.

Next on the radar will be Portugal, which also spent too much over the last several years, building its debt up to 78% of GDP at the end of 2009. By 2012, Portugal’s debt-to-GDP ratio should reach 108% even if the country meets its planned budget deficit targets (which are questionable to say the least). And because EU money will be there for anyone who wants it, Portuguese politicians are likely to do basically nothing while they wait for their bail-out package which will again be financed by the ECB’s printing press.

The inevitable result will be Germany, which as the world’s 3rd largest exporter has a vested interest in seeing the euro decline, growing tired of bailing out weaker European countries. The longer this system continues, the more debt will be built up and the more dangerous the situation will get.

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April 22nd, 2010 @ 11:37 am by Matt "NewstraderFX" Carniol

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Actually, doomed might be too strong a word to use. Let’s just put it this way and say that the common currency is headed for another serious decline, most likely to the lower 1.20’s if not below that.

There’s no end to the debt crisis, no matter what government officials say. The market has put its stamp of disapproval on the situation, which basically means it has little if any faith in the future of Greece as a functioning economic entity capable of handling its own finances. In essence, Greece is just another bad credit risk, a borrower with a credit score below 500.

Greece’s benchmark 10-year bond yields rose to 8.56% by Thursday morning, the most since 1998 and more than double the rate on comparable German debt. Since April 12, the day after the EU said it would provide a backstop by offering 3 year loans at 5%, Greece’s 10-year government bond has surged more than 100 basis points. What that tells you is that the market has little faith in this solution in that it doesn’t solve the essential problem; Greece will never be able to generate enough income to pay down its burgeoning debt. The only thing it can do is to cut spending, which, can only go so far.

Think of it this way. Would you lend to a borrower deemed as a bad credit risk if all you had were promises that it would cut back on spending for things like gasoline and food? This is what austerity means to the average Greek citizen on the street-less money for essentials. The population is so angry about the situation; they’re striking at hospitals and airports (which truly is a case of cutting off one’s nose to spite its face if there ever was one).

What is a nation in economic terms but another “store” on a street called “the world”. The only way it can generate income is by producing products it can trade or by charging admission to people who wish to tour its interior. The problem is that Greece produces basically nothing and while there always will be people willing to spend in order to view its beauty, a national economy cannot survive on tourism alone.

The only option left to Greece is to allow itself to come under the control of the IMF, which is basically what a bailout entails; as a new creditor, the IMF gets to write the rules regarding how the government will operate in terms of all things fiscal.

In any event the Germans are certainly getting exactly what they want, which is to be off the hook for covering Greek debt and a depreciating euro. Actually, the entire area needs to have a serious devaluation of its currency in order to make its exports of cars, high-tech machines, chemicals, etc. more competitive. Stores called “Germany”, “France” and, to a lesser extent, “Italy”, have the products that people with money (Asians) want.

So, look for the euro to head down towards $1.20 at least until China allows the yuan to appreciate at some point in the not too distant future.

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April 18th, 2010 @ 7:04 pm by Matt "NewstraderFX" Carniol

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With Goldman Sachs (ticker: GS) being sued by the Securities and Exchange Commission (SEC) for fraud over subprime CDO’s gone bad, the potential is there to see a measure of risk taken off the table the table over the next few days.

And as we’ve seen, when risk comes off the dollar gets bought.

We certainly saw that on Friday as the greenback advanced against the better-yielding euro, pound, Australian and New Zealand dollars while the S&P declined by 1.6%. Meanwhile, GS lost over $10 billion of market cap and financial shares declined an aggregate 3.8%. As always, commodities like oil fell and Treasuries advanced while traders grew more skittish.

Going forward, there’s now an element of uncertainty which didn’t exist prior to the disclosure. For one thing, it’s doubtful that this particular transaction was the only one of its kind that Goldman was involved with. Indeed, the British and German governments gave early indications that they plan to do a bit of digging themselves, and we already know that Goldman helped Greece hid the extent of its deficits with interest rate and currency swaps.

As a trader, it’s always important to look at what happened to the markets under similar circumstances. The problem here is that basically, as far as I can tell, no one has ever traded through an SEC fraud allegation of one of the world’s biggest investment banks while the global economy is at the early stages of recovering from a devastating credit crisis.

That’s why a simplification of the situation sometimes the best approach. To my way of thinking, if it looks like garbage and it smells like garbage then it must be garbage, which means that we’re likely to see a continuation of what happened last Friday at least over the next few days.

The problems related to GS aren’t the only ones which could cause stocks to take a tumble (and cause the dollar to advance). For one, China is making some moves to pressure its growing real estate bubble by requiring higher down payments and limiting loan amounts for non owner-occupied homes and apartments. Prices in the big city coastal areas are already several multiples above what even a two income household can afford to carry.

Still, in the longer term, there’s every reason to believe that investors will go long once they spot a bargain. It’s highly unlikely that Goldman is going to come out of this with anything more than a few bruises and some blows to its pride. People are not going to permanently stop doing business with them.  It does look bad now, and it is, but Goldman is not going out of business and the banking system is not going to seize up as it did after Lehman collapsed.

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April 2nd, 2010 @ 8:07 pm by Matt "NewstraderFX" Carniol

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Good Friday’s Non-Farm Payrolls report showed that more jobs (162,000) were created in March than for any month in the past three years. Private payrolls (excluding 39,000 governments jobs) increased by 123,000, the third consecutive increase. All told, the January and February job counts were increased by a combined 62,000, putting the March gain at 224,000 when added together, including  temporary workers hired for the 2010 census.

Employment of private temporary workers, considered to be a leading indicator of permanent hiring, climbed in March for a sixth consecutive month but their share in the payroll count is diminishing, showing companies are becoming more optimistic.

The report will have important implications for a variety of asset classes, so let’s look at what could happen.


Stocks are likely to remain on the upswing that began in March 2009 as the S&P 500 moves inevitably to the pre-Lehman collapse level of around 1250. In the beginning of the year, I said that the S&P would hit this level by the end of the first quarter and while that didn’t happen, this important benchmark is bound to be reached soon. Simply put, stocks have followed the improving trend in jobs for months and there’s no reason to believe that will change now.

The Dollar

In my opinion, because the recovery appears to be gaining strength, the Fed will drop the “extended period” language by the end of this quarter, possibly at the June meeting, and make its first move before the year ends. The reason is that the Central Bank moved to a 0%-0.25% interest rate policy under “emergency” conditions which no longer exist, and a symbolic move away from this extraordinary stance will serve as a signal to the market that officials are gaining confidence in the recovery.

As the market moves to this perception, the dollar will gain against the pound, aussie and yen. The big move figures to come against the euro because, due to the fiscal problems affecting Greece, Ireland, Spain, Portugal and Italy, the ECB will be among the last Central Banks to make a move on rates. The yen seems destined to head towards 100 to the dollar as Japanese investors seek better returns abroad and because Japan’s currency should assume its role as the major funding vehicle for carry trades.


Rates on government debt will continue to move up as the recovery gains momentum. We’ve already see the 10 year note surpass 3.9%, and a move above 4% by the summer will no doubt be seen. That’s going to affect mortgage rates, which could finish the year around 5.5% for 30 year loans.

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March 28th, 2010 @ 3:45 pm by Matt "NewstraderFX" Carniol

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A cautious optimism is the best way to describe my feelings on where the S&P is headed while the dollar is most likely to see some measure of decline, at least in the early going this week.


The market suffered a late-day sell off on Friday after rumors of a South Korean naval vessel being sunk as a result of a conflict with North Korea spread. The won also dropped against the dollar. However, “given the investigations by government ministries so far, it is the government’s judgment that the incident was not caused by North Korea, although the reason for the accident has not been determined yet,” a senior government official was quoted as saying by Yonhap news agency in South Korea.

Presidential Blue House spokeswoman Kim Eun-hye earlier said there had been no unusual movements by North Korea.

Purchases are expected to have increased by 0.3% and incomes likely rose 0.1% in Monday’s report from the Commerce Department. Sales have been increasing for the last 4 months while incomes are looking for a second monthly gain.

The Conference Board’s confidence index, scheduled for release on Tuesday, probably increased to 50 from 46 in February.

On Friday, economists are expecting to see a gain of 190,000 jobs in March, the biggest increase for 3 years.  Some of the boost is expected to come from the hiring of temporary government workers to conduct the 2010 Census and from better weather. The unemployment rate is expected to hold at 9.7% for a third straight time. Unemployment peaked at 10.1% last October.

From a technical viewpoint, price has appeared to have found support near the former resistance at around 1150 and the longer it holds above this level, the more confidant investors will feel.

The Dollar

We’ve been down this road before, but it appears as if traders are satisfied with the latest developments regarding the Greek debt situation. A plan announced at the conclusion of meetings in Brussels on Friday which will involve the use of a joint IMF-EU backstop, should one become necessary, led the euro to a 124 pip gain on the day.

What has become evident is that the Federal Reserve now seems far more likely to make a move on interest rates ahead the ECB, although when exactly that might happen still appears to be a ways off. Bernanke reiterated that the employment situation is still “very weak” during congressional testimony last week and reports showed that inflation continued to remain tame.

In fact, dis-inflation seems to be the rule of the day. Core CPI rose just 1.3% in the year to February and the trend appears to be slowing as well; the core measure rose just 0.8% annualized in the 6 months to February, less than half the 1.9% increase seen in the prior 6 month period. In the last 3 months, core has risen at an annual rate of just 0.1%.

However, current monetary policy was implemented under emergency conditions and the facts are that the situation has changed. Credit spreads are low and corporations have easy access to capital markets. Profits are expected to increase by 30% this year and the economy could see 3% growth. Quantitative easing (aka the printing of dollars), will officially end this month although the Fed has left the door open to additional measures, should they become needed.

Bottom line-the dollar is most likely to continue its strengthening trend as the year progresses, especially against the euro. In my opinion, $1.20 to the euro, and even below, is well within the realm of possibility under the current economic outlook.

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March 23rd, 2010 @ 12:05 pm by Matt "NewstraderFX" Carniol

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I last wrote that I was bullish on the S&P 500 and bearish on the dollar, so let’s review what’s happened since then and where things stand now.

As far as the S&P is concerned, the overall bias is still to the upside. There is, however, a very good technical indicator that I’m looking at which help determine its ultimate direction. As previously mentioned, price stalled in mid-January around the 1150 level and corrected by about 9.4%. From there, is appreciated fairly strongly and eventually made a double-top which was surpassed last Tuesday.

What’s interesting is where the double-top occurred, which was almost exactly at the 80.9 fibonacci level (80.9 is the next number in a fib sequence that begins with the number 50).

Now, it’s very common to see an area that has acted as strong resistance in an uptrend then act as support once price has gone beyond it. In other words, price will frequently retrace back to the resistance area (in the case near 1150) and look for buyers. If support is found, that can be taken as confirmation that the original uptrend is intact.

So, the first mistake I made last Thursday was to not take into account the possibility that the S&P could follow this typical price action. When you look at the movement from last Friday and Monday, that’s pretty much what you’ll see because after declining on Friday, the S&P came even closer to 1150 on Monday before advancing. The former resistance has now acted as support.

As far as the dollar is concerned, what happened on Friday was almost comical. In fact, if you really want to have a career as a trader, you have to be able to laugh when things like this happen.

First, the Greek debt crisis is not over. On Friday, Germany opened up a serious rift with the France and the ECB by saying that if a crisis does truly exist, Greece should look to the IMF for support. Greek Prime Minister George Papandreou threatened to do just that because the country can save hundreds of billions in borrowing costs by doing so (Greece has to pay over 6.3% if it issues its own 10 year bonds vs. less than half of what it would pay for IMF funds).

What’s obvious is that in this case, the European Union cannot, or will not, handle its problems internally which means that the very existence of the euro itself has to come into question. So, without an aid package (meaning either funds or guarantees) which will allow Greece to borrow in the open market at a comparable cost to the IMF, Greece will indeed take the radical step of going to Washington the cover the 40 billion euros it has to refinance this April and May. And that will take the common currency into the lower 1.20’s against the dollar.

But even so, no matter what happens in terms of where Greece eventually ends up getting financing, the austerity programs it has put in place, along with similar programs in Ireland and Spain (with Portugal and Italy not far behind), virtually insures that Europe will dip into a second recession because what’s happening is that taxes are being raised and government spending is being cut back (out of necessity) at the precise time when the exact opposite should be happening.

So, when you’re wrong, the first thing to do is to relax and have a laugh over it. But don’t waste too much time because when you’re wrong it also means that it’s the time to do some further research.

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