What's Next For The Euro?

by: Ralph Shell

Among this week's fundamental economic releases was the US fourth quarter GDP Report. The Annualized Q/Q rate of growth was 3.2%, almost the anticipated 3.3% rate of growth. This, however, still resulted in an annual 2013 growth rate in 1.9%, less than 2.8 last year. Some think this gives the US some momentum going forward despite some negative numbers reported.

Weekly unemployment numbers were up to 348K. US Pending home sales were down 8.7%, but then, who wants to look for a house or a job in the middle of a very bad winter? Looking forward to next week, the current estimate for the US Non Farm Payroll report is 175K. Chances are this same nasty winter is going to give us poor job creation numbers. How will this play with the various markets?

Perhaps these numbers will give the US some momentum going into the first quarter. Also the consumer was busy supporting the economy during the last quarter, with personal consumption up 3.3%. Our take is the US consumer is getting squeezed with higher product costs and a higher government take from their income and this will not continue.

There is also the issue of the Affordable Health Care Act. Van R. Hoisington and Lacy H. Hunt, Ph.D. recently published their opinions, a projection of what might happen in 2014. A dose of caution is perhaps needed:

"An important fiscal policy event for 2014 is the Affordable Care Act (ACA). Healthcare is the largest U.S. industry, comprising 17.2% of the economy in 2012. This is more than twice as large as residential construction, oil and gas exploration and the automotive sectors combined. The scope and scale of ACA may divert energy and activity away from more productive endeavors. The ACA's employer mandate was waived in 2013, as were similar obligations of labor unions and others, but these waivers expire this year. Firms may have to cut some full time employees to part time, reduce total employment or cut benefits since they lack pricing
power t
o cover these costs. As such, this will place the burden of adjustment on consumers. On January 1, health insurance premiums that target small businesses and individuals were raised. These groups create jobs and are vital for growth, thus even though the amount of the increase is small, this is still a net drag for economic growth. While the ACA is an unprecedented event for which no historical point of comparison exists, history does confirm that substantial increases in government regulation are not a springboard for innovation, the lifeblood of economic activity."

Over time, the research conclusions of this group have been sound. Ignore them at your own risk.

Since the recovery from the 2008 recession, it seems US fiscal and monetary policies have been marching in different directions. The Fed injects money into the economy and the various and numerous government entities try to get as much of that money as they can. This is a plan for no growth in the US private sector which will weigh on the US economy later this year.

Where then, do we look for economic leadership? This past week, coming back from Davos Switzerland, Ambros Evans-Pritchard gave us little hope this economic leadership would come from Europe. He also claims:

"Half the world economy is one accident away from a deflation trap. The International Monetary Fund says the probability may now be as high as 20pc.

It is a remarkable state of affairs that the G2 monetary superpowers - the US and China - should both be tightening into such a 20pc risk, though no doubt they have concluded that asset bubbles are becoming an even bigger danger....."

The first month of 2014 has been a difficult one for the Emerging Markets. It is estimated that as much as $4T of investments have poured into the EMs. Momentum funds may have been the last to enter. Fearful of the impact of the Fed's taper, the global tremors of capital flight has impacted many currencies this past week including those of India, Russia, South Africa, Turkey and others. Are the momentum funds now taking the hot money back to its source?

A major question here is, if this the beginning of a trend, or is it merely re - positioning of funds at month end. Considering the amount of international hot money, a partial product of the Fed's QE injections, I suspect this capital movement will continue, but will it continue to favor the USD?

Last week our analysis of the COT Report showed specs had been busy acquiring the biggest USD long position since August of 2013. This tends to make us cautious but with the vast amounts of money looking for safety, where else will the money flow?

The EU hardly seems like a likely destination for this money. When Draghi said he would do "whatever it takes to defend the euro," this braggadocio seems to have excluded actions that might harm the Bundesbank. This week the EU M-3 money supply was up only 1%, a level too small to sustain the fledgling recovery, but rather one destined to push Italy and Spain back into a recession.

The situation in Italy is most acute. Italy has the third largest amount of sovereign debt in the world, and the ECB auditors are coming for a visit. A recent Reuters story commented of the situation:

"Italian banks are near saturation point after two years spent frantically buying their own government's bonds, forcing the Treasury to find alternative investors at home and abroad to finance a 2-trillion euro debt.

Lenders' ability to soak up yet more Italian sovereign debt depends largely on the European Central Bank - which in turn says Italy is crucial to the fate of the entire eurozone."

But with the Bundesbank in control of the EU money supply, we must get ready for another crises in the ongoing euro drama.

The EURUSD (CCX, DBV, DRR, ERO, EUFX, EUO, FORX, FXE, UDN, UDNT) hit our target of 1.35 and we are inclined to step aside. Perhaps many of these issues are price in the market. Our trading preference for early next week is a rally back to the 1.36 level where we wish to sell. If the pair takes out support around the 1.3460 there may be another 200 pips to the down side. As always mind your money.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.