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Wednesday, March 24, 2010 5:02 PM

Slow Motion PIGS Wreck; Dollar Soars as Contagion Spreads to Portugal; Greece "will default at some point"; What's Next?

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The US dollar soared today in the midst of a crisis in the Eurozone no longer contained to Greece. Please consider Portugal’s Debt Rating Lowered by Fitch on Finances

Portugal’s credit grade was cut by Fitch Ratings for the first time, underscoring growing concern that Europe’s weakest economies will struggle to meet their debt commitments as finances deteriorate.

The rating was lowered one step to AA- with a “negative” outlook, Fitch said in a statement today, adding that further economic or fiscal underperformance this year or in 2011 may lead to another downgrade. The euro extended its decline, dropping against all but one of the 16 most-traded currencies. Portuguese stocks and bonds fell.

“A sizeable fiscal shock against a backdrop of relative macroeconomic and structural weaknesses has reduced Portugal’s creditworthiness,” Douglas Renwick, associate director at Fitch, wrote in the statement from London. “Although Portugal has not been disproportionately affected by the global downturn, prospects for economic recovery are weaker than 15 European Union peers, which will put pressure on its public finances over the medium term.”

The governments of Greece, Ireland, Italy and Spain are seeking to narrow budget deficits that have swollen as their economies have been battered by the recession. Portugal’s deficit is 9.3 percent of gross domestic product, more than triple the European Union’s 3 percent limit. Failure by the EU to agree on a mechanism to help countries shore up their finances has hurt the euro, putting it on course for its worst quarter against the dollar since 2008.

The Portuguese and Greek economies may face a “slow death” as they dedicate a higher proportion of wealth to paying off debt and investors drive up government borrowing costs, Moody’s said on Jan. 13. While the two countries can still avoid such a scenario, their window of opportunity “will not be open indefinitely,” Moody’s said.
Slow Motion PIGS Wreck

PIIGS stands for Portugal, Ireland, Italy, Greece, and Spain. I dropped an "I" to focus on the "Club-Med" countries.

Bloomberg reports Euro Drops as Portugal Downgrade Underlines Concern on Greece
“Fitch opened up another front against the euro,” said Alan Ruskin, head of currency strategy at Royal Bank of Scotland Group Plc in Stamford, Connecticut, who predicted the euro may fall to $1.10 if Greece defaults or leaves the euro area. “You’re tracking two stories at the minimum -- how Greece is going to get funding and a subplot related to Portugal.”

The 16-nation euro area may be “at the early stages of what may prove to be” a breakup, according to Roger Bootle, a former U.K. Treasury adviser. The currency may weaken to $1.25 by year-end as widening budget deficits in nations such as Greece expose the reluctance of stronger countries to come to their aid, said Bootle, founder of London-based research company Capital Economics Ltd.

Spain will probably be the next fiscal crisis in the region as Greece heads toward a “slow-motion train wreck,” economist Gary Shilling, president of A. Gary Shilling & Co. in Springfield, New Jersey, said today in a Bloomberg Television interview.
Brazil Real Falls on Portugal’s Credit Downgrade

Inquiring minds note the Brazil Real Falls Most in a Week on Portugal’s Credit Downgrade
Brazil’s real fell the most in almost a week as Portugal’s credit-rating downgrade at Fitch Ratings raised concern government deficits will derail a global economic recovery.

“The Brazilian real is even more vulnerable to the external environment,” than before, analysts at BNP Paribas wrote in a note to clients. Any recovery in the real should “prove to be an opportunity to buy the dollar,” they wrote.
Greece Will Default Says UBS Head Of Global Economics

Please consider Swap Spreads Plunge as Portugal Downgrade Boosts Risk
“The rise in sovereign risk we’ve seen, heightened by Portugal’s downgrade today, has definitely raised the tension being paid to the risk of government debt and appetites for it have waned,” said Brian Yelvington, head of fixed-income strategy at Knight Libertas LLC, a Greenwich, Connecticut-based broker-dealer. “The increased sovereign risk is pressuring Treasury yields higher and creating investors’ preference for riskier assets like corporate debt, which causes demand to receive fixed in swaps, all of which work to compress swap spreads.”

France and Germany are nearing agreement on International Monetary Fund involvement in any aid package for Greece, burdened by the European Union’s biggest deficit, according to a finance ministry official in Berlin. The Portugal downgrade spurred concern that more European nations will struggle to fund swelling deficits.

Greece “is going to default at some point,” and Europe’s failure to answer that challenge will hurt the common currency, UBS Investment Bank’s London-based deputy head of global economics, Paul Donovan, said in an interview on Bloomberg Radio.
What Next?

Once again we so just how correlated everything has been in anti-dollar plays now starting to unravel. Please consider Aussie, New Zealand Dollar Fall After Portugal Credit Downgrade.
The Australian and New Zealand dollars fell against their U.S. counterpart as Fitch Ratings cut Portugal’s credit grade, fueling concern Greece’s fiscal crisis will spread and driving investors to the perceived safety of the greenback.

The Aussie touched a two-week low against the U.S. dollar before a European Union summit opens tomorrow. New Zealand’s currency, nicknamed the kiwi, slid earlier after a report showed the nation’s current-account deficit widened more than forecast.

“The Aussie-U.S. dollar should continue to trade in tandem with risk, and the situation in Greece ahead of the European Union summit later in the week is likely to continue to weigh on the pair,” a team led by London-based Hans-Guenter Redeker, global head of foreign-exchange strategy at BNP Paribas SA, wrote yesterday in a report.
US Dollar Weekly Chart

click on chart for sharper image

While hyperinflationists were engaged in dollar countdown to oblivion madness, I had a technical target on the US dollar at 82.5.

After hours I see the dollar trading at 82.30.
That's close enough. I declare victory.

Why did I think the dollar would rally?

1. Anti-dollar sentiment was more extreme in April of 2008 than October of 2009.
2. I thought the problems in Europe were far bigger than anyone realized.
3. I thought the problems in the US were well understood and over-hyped relative to the problems elsewhere.

Anti-dollar sentiment has now worn off and is replaced by anti-euro sentiment. However, please remember sentiment can run a long time, especially with currencies.

What's Next?

To be honest, I don't know, but nor does anyone else. At least I admit it. Technically, the next target for the dollar index is the congestion zone in the 84-87 range.

That does not mean it gets there. Please remember my overall thesis was the US dollar bottom is in, (at least for quite some time), and that the dollar would remain in a broad trading range between 70 and 90.

For now....

  • US dollar momentum is clearly up.
  • Technical analysts should be able to spot two bull flags in this uptrend.
  • Contagion has spread to Portugal.
  • Spain is likely next and Italy after that.
  • China is on an unsustainable growth pattern with clear implications on the commodity producer currencies.
  • Far too many are still US-centric, blind to problems elsewhere.

The dollar can (and probably will) go a lot higher than most pundits think. Then again, with many inflationists predicting an imminent crash, it already has.

Mike "Mish" Shedlock
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