Most investors have their rose tinted glasses on this morning
thanks to better than expected economic data from China, Germany
and the U.S. The resilience of the EUR/USD and risk appetite in
general is remarkable considering that the market's greatest fears
of a downgrade of Europe's second largest economy and the European
Financial Stability Fund have now been realized. In retrospect
perhaps these downgrades may have been discounted by the markets
and countries such as Japan have been quick to say that the
downgrade will not affect their purchases of EFSF bonds. Damage
control is clearly in full swing with France's Finance Minister
saying there is no need to act on the EFSF after the downgrade.
Even with these reassuring words, it is hard to believe that the
EUR/USD can sustain its gains given the severe consequences of
recent rating actions. Nonetheless we have to respect the rally
even if it is largely caused by short covering. Investors were
first relieved to see evidence of a soft landing in China with GDP
declining less than expected in the fourth quarter. The relief
rally in the EUR/USD and other high yielding currencies gained
momentum after Germany reported much stronger than expected
investor sentiment numbers. The optimism in the market was further
supported by the higher Empire State manufacturing index which rose
to 13.48 in January, signaling continued momentum in the sector. We
are extremely surprised that investors have completely overlooked
the warning by Fitch that Greece will be unable to meet its March
bond payment which would effectively put them into default.
Discussions with Greek creditors will take place later this month
and if additional aid is not disbursed, then a default would be
inevitable. Many people will argue that Greece should just default
on its loans but one of the main reasons why Europeans across the
region want to avoid a default is because the ECB owns EUR45
billion worth of Greek bonds and a default by Greece will make it
difficult for them to justify buying other government bonds.
Bank of Canada Keeps Rates Unchanged
Meanwhile the Bank of Canada left interest rates unchanged at 1.00
percent and adjusted their growth forecasts. For 2012, they expect
a "more modest recovery" that will boost GDP growth to 2 percent
from a prior forecast of 1.9 percent. They also believe that the
economy grew by 2.4 percent last year compared to a prior forecast
of 2.1 percent. Even though the BoC predicts a stronger growth this
year, the tone of the monetary policy statement wasless optimistic
than the previous month. The central bank started off by saying
that the outlook for the global economy has deteriorated and
uncertainty has increased since their last monetary policy report.
The sovereign debt crisis in Europe has intensified and measures to
pare debt around the world will slow growth in Europe and the
recovery in the U.S. For this reason, the central bank remains
comfortably on hold for the time being and will monitor
developments in Europe and North America before making any new
decisions.