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Gold Back on the Defensive as Dollar Bounces

Gold is being weighed upon by a bounce in the dollar, which was lifted by a number of events along with renewed tempering of QE2 expectations.

Rumors circulated overseas about a possible US/China currency accord ahead of the G20. The gist of which was that China was willing to trade yuan reform for a smaller round of QE. First of all, the Fed doesn’t negotiate with foreign powers and they are supposed to operate independent of Treasury and the legislative branch. This was a silly rumor to begin with. Secondly, we’ve heard talk of currency reform in the past and it has yet to amount to anything. This has been largely discounted by the market at this point.

In Europe, Greece’s finance minister said that his country’s 2009 budget deficit would be set “once and for all” at above 15% of GDP. You may recall that the revision of the deficit figure from 3% to 6% of GDP in October of last year was pretty much the trigger for the European sovereign debt crisis. There have been a couple interim revisions higher, but 15% of GDP! No wonder some very smart people, including Nouriel Roubini and PIMCO’s Mohamed El-Erian, are convinced that a Greek default remains inevitable. Not surprisingly, the spread between Greek debt and benchmark German bunds has soared once again and the euro has retreated.

This latest revelation about Greece’s fiscal problems comes just as the EU decided the Stability and Growth Pact would have no teeth. Germany’s Angela Merkel caved to France’s Nicolas Sarkozy’s demand that there be no automatic sanctions for fiscally irresponsible EU members (like Greece). The German-Franco deal was in fact an end-run around the EU and Jean-Claude Juncker is none too happy about that.

WSJ FedWatcher John Hilsenrath has once again published an article that suggests the Fed’s QE2 campaign will be smaller rather than larger, “a few hundred billion dollars over several months.” He does however hint that the Fed may go with an open-ended approach saying, “officials want to avoid the “shock and awe” style used during the crisis in favor of an approach that allows them to adjust their policy, and possibly add to their purchases, over time as the recovery unfolds.” …or as the recovery fails to unfold…

KC Fed’s Thomas Hoenig continues to do his part in tempering expectations as well, using his strongest language yet. Speaking on Monday at the University of Kansas, Hoenig said more expansive monetary policy was a “bargain with the devil.” I wonder if the FOMC will channel Flip Wilson next week if QE2 ultimately is at the high end of expectations: “The devil made me do it!”

Disclosure: None mentioned