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July 28, 2010, 08:00 EST		 Dr. Joe Duarte's Market I.Q.


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Foreign Currency Borrowings By Consumers Could Be The Next Euro Worry
What's Hot Today:

U.S. stock index futures were rising in early pre-Wall Street action. The S & P 500 is entering a critical trading band between 1115 and 1131.

Today's Economic Calendar


News For Thought

Obama heads to Wall Street for fundraisers, but could have difficult time. According to The Wall Street Journal: "President Barack Obama heads to New York City on Wednesday for a pair of high-dollar fund-raisers—a tough task given the many Wall Street executives who are put off by his rhetoric and policies. Mr. Obama raised a record $15 million from Wall Street donors for his presidential campaign, but his relationship with many of those donors began to fray not long after he took office, and donations have fallen. Wall Street executives "feel like a spurned lover," says Paul Equale, a financial-services lobbyist who also advises Wall Street firms on dealing with Washington."

Europe hopes to close fiscal holes via online gambling. According to The New York Times: "Across Europe, cash-strapped governments looking for ways to reduce yawning budget gaps are embracing online gambling, a source of revenue they once viewed with wary skepticism." The Times added: "more and more gamblers are spurning land-based casinos anyway, and logging on to Internet poker and sports betting sites — many of them based in places that are out of reach of tax collectors. As public finances worsen, governments are trying to bring this once-shadowy business into the mainstream of Europe’s digital economy, where it can be regulated and taxed."

Foreign Currency Borrowings By Consumers Could Be The Next Euro Worry
Hungary And Romania May Be The Next Euro Crisis Centers
The Euro has been bouncing back against the dollar for the last month. But the swings in the currency have had a negative effect on European borrowers that have debt denominated in foreign currencies.

According to The Wall Street Journal, many Europeans took out loans in foreign currencies, such as the Swiss Franc, which offered lower interest rates at the time of the loan. The problem is that as rates have risen, and exchange rates have changed, in many cases, the original monthly payment has risen significantly, turning the loan into an albatross around the borrower's neck. In many cases, the loans were taken out in order to expand or improve businesses that were on sound footing and steady growth paths. But the new debt burden is now threatening many of these businesses, adding a new layer of potential problems to the already limping European economy.

The surprise of the day was the breakout for the Dow Jones Industrial average (INDU), which is the leading index in this latest rally. Much of that may have to do with the dollar's persistent weakness. Most of the stocks in the Dow are export companies which are aided by a weak dollar.

And in many cases, the business was tied to the borrower's home, which is now in danger, in many cases of being foreclosed. In fact, the Journal reports that this is a widespread enough problem leading to a situation in which "Households and small businesses across Central and Eastern Europe are sinking under the weight of foreign-currency debts. It's a sign of how the problems facing the region's financial system go beyond the borrowing by spendthrift governments that has been the main focus of investors."

The repercussions are not just toward those who are about their businesses and their homes, but also include the banks that made the loans. According to one expert, quoted by The Journal, the risks are "potentially huge," adding ""The risks are potentially huge," says Neil Shearing, senior emerging-markets economist at Capital Economics in London. "It wouldn't take very much to create a big squeeze on some banks."

And at the center of the situation seem to be Hungary and Romania. According to The Journal: "Hungarian households collectively have about $32 billion in outstanding foreign-currency debt, mostly in Swiss francs and euros, according to the Hungarian central bank. Aside from local players, about a half-dozen foreign banks—from Austria and elsewhere in Europe—have a significant presence in Hungary." In fact "consumers' debt woes are acting as a brake on the region's economic recovery as households use income to pay off loans instead of spending, damping domestic demand. The foreign-currency borrowings also constrain economic policy makers since swings in interest rates and currency values can drastically change the fortunes of indebted households and companies."

The Journal added: "In Romania, one of the European Union's poorest members, more than 60% of household borrowing is in foreign currency. In Poland, the figure is 36%. In the Baltic states, the proportion ranges from 70% to more than 90%. In Hungary, nearly 70% of the country's total household debt was borrowed in foreign currency. The sharp slide in the Hungarian forint, which since the summer of 2008 has fallen about 20% against the euro and some 30% against the Swiss franc, has meant large increases in the local-currency cost of repaying these loans."

Conclusion

Hungary and Romania may seem small in the context of Europe and the world. But their situation is serious, when condidered conceptually. This is especially important when you consider that a significant amount of the borrowed money came from foreign banks doing business in Hungary and Romania.

It's those banks, and their potential problems that could be the key step in another round of currency market instability, with the recently resurgent Euro running into more trouble.

The bottom line is that the Euro is trading at about 1.30 vs. the dollar and having trouble. If the Euro continues to struggle at these levels against the dollar, it makes sense to consider that the markets are starting to factor in the potential effect of a Greece style problem in Hungary and Romania, and perhaps elsewhere in Europe.

We'll be on Twitter some time today before the market closes with some updated comments.

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Market Moves - Stock Of The Day
Currency Shares Eurotrust ETF (NYSE: FXE) Reaches Key Chart Area
The Currency Shares Eurotrust ETF (NYSE: FXE) is struggling at the 130 area, correspoding to the 1.30 area vs. the dollar.



Chart Courtesy of StockCharts.com


Currency traders like to make round numbers their decision points, which is why 1.30 is an interesting chart point for the Euro, which has bounced back strongly vs. the dollar lately.

If you go to the things that move currencies, interest rates, political stability, and the state of the underlying economy, though, you have a mixed bag when evaluating the relationship between the Euro and the dollar.

The U.S. economy may be a bit stronger than the European economy, but things are in flux. That gives a slight edge to the Euro. Interest rates are higher in Europe, which gives the Euro the edge. Now, though, you get to politics, which is the most nebulous of the factors involved here.

Germany and France, the big powers in Europe are not exactly beacons of political strength. France's president is involved in a campaign related political scandal, and Germany's government seems to limp from vote to vote. In the U.S. the Congress and the White House are blinded by ideology and talk, and are doing little to incentivize businesses to expand and add jobs.

That means that it's the politics that are the centerpiece of what will happen in the currency markets, from which all other markets will take cues.

A weak dollar may be good for export businesses, but a strong dollar may be a sign that the U.S. political situation is improving. At some point, we believe the latter will have better long term repercussions.

Dr. Duarte owns shares in the U.S. Dollar Bull ETF (NYSE: UUP).

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