Big Al's Talking Recession

Good day… Well… Our day without data yesterday turned sour for the dollar early on, and has kept that trend in place throughout the overnight sessions. The euro crossed the 1.32 level last night, and moved as high as 1.3231 before the February retail sales for the Eurozone stopped that move dead in its tracks.

Yes, retail sales fell in the Eurozone in February… But before we go out and put sandwich boards on with messages that the sky is falling on the Eurozone economic recovery, let’s remember Germany’s VAT (added tax) that began in January. It’s going to take some time before that new tax is swallowed up by a surging economy. In other words, it will take some time to forget the pain! Germany, the Eurozone’s largest economy, put the VAT in place, and Germany was the country that experienced the largest drop in retail sales. So… One and one is two, carry the one, and use the ladder method to get the greatest common multiplier, and you see that Germany’s VAT caused this slide… But no worries.

OK… Did you see/hear our former Fed Chairman Big Al Greenspan talking about the U.S. economy yesterday? Well get this… Big Al says that the U.S. budget deficit is a “significant concern” and that a recession is possible by year-end. Recall, that George Soros, (I don’t really like this guy, but he said something that makes sense), said last year that the United States would experience a recession by the end of 2007.

You might also recall that yours truly, along with my friend John Mauldin, pointed out the inverted yield curve months ago, and explained that historically an inverted yield curve indicates that a major slow down/recession is on the way. So… Big Al is jumping on our bandwagon, eh? Well… That’s OK. We have plenty of room right now, as most economists/observers haven’t even opened their eyes to this potential problem. Oh OK, Dr. Richebächer called for a recession too!

The European Central Bank (ECB) Governors have been out in force recently, and all singing from the same song sheet that contains the word “vigilante”. Yesterday, it was the ECB’s Qaden sounding hawkish with a statement that the, “ECB GOVERNING COUNCIL IS IN POSTURE OF STRONG VIGILANCE.”

Any time we’ve seen the use of the “v” word, the ECB has followed with a rate hike. So, as I’ve said over and over again, this dance is gonna be a drag. No wait, that’s really going back a few years for the Dave Clark 5! But what I was trying to say before I went off on a music tangent, is that I’ve said it over and over again, that the ECB will, in my opinion of course, raise rates next week at their meeting on the eighth.

Of course there are other things the ECB Governors have been on their soapbox about lately… And one of those things is the weakness of the yen… And the carry trade. Both ECB President Trichet, and Belgium’s minister have been out warning people about the dangers of thinking that yen is a “one way trade”, especially after seeing that Japan is now enjoying their longest period of economic expansion since WWII.

Speaking of yen… Maybe all the jawboning about it being so weak and needing to get stronger is swaying the markets a little. The Japanese yen has gained two whole yen in the past week. Of course when I can say that yen has gained 10-15 whole yen we’ll be dancing in the streets with lampshades on our heads! Now that’s a funny image!

Have you seen all the negative news stories regarding the subprime mortgage loan problems? Aye-Carumba… This is getting U-G-L-Y! These subprime loans aren’t getting hit with the ugly stick… Oh-no, it’s more like the whole ugly forest! Again, here I am talking about my friend John Mauldin. But John did a great job explaining it all in his February 17 letter…so I’ll give you some excerpts.

First of all… Generally, subprime mortgages are for borrowers with credit scores under 620. Credit scores range from about 300 to about 900, with most consumers landing in the 600s and 700s. Someone who is habitually late in paying bills, and especially someone who falls behind on debts by 30 or 60 or 90 days or more, will suffer from a plummeting credit score. If it falls below 620, that consumer is in subprime territory. Subprime loans have higher rates than equivalent prime loans.

OK… Now that I’ve explained a subprime mortgage, here are the excerpts from John’s 2/17 letter… “A decade ago subprime mortgages were a mere $35 billion. Today they are one-fourth of all mortgages, about $665 billion. Somewhere in the neighborhood of $1 trillion in adjustable-rate mortgages [are] eligible to be reset in the next two years, sharply increasing payments and lowering the discretionary spending ability of those homeowners.”

I know, I know, you’re wondering what this has to do with the threat of a recession. Well, grasshopper, it’s quite simple really… Mortgage Equity Withdrawals (MEW’s) have been fueling this economy. John tells us, “MEW’s accounted for over 2% of last year’s GDP growth.”

Uh-oh… That looks scary. If MEW’s accounted for a majority of consumer spending and that the ability of those consumers to withdraw is going to be sharply lowered…guess what that does to an economy.

I’m not trying to be Gloom & Doom here. I just want to bring this to your attention, in hopes that you make the moves in your investment portfolio that will protect you from a potential recession, which cannot be good for the dollar, eh?

Oh… And if you’d like to read John’s complete letter that contains his thoughts on housing.

Gold gave back some of its gains last night, which is to be expected given this huge move in the past week. I suspect this move downward will be short-lived, so if you were waiting for a better price, this could be it! Oil remained above $61, which is a good indicator to me that this dip in the price of gold will be short-lived.

The strength of Japanese yen overnight, and a further strengthening of Singapore dollars, pushed the Chinese renminbi higher. Recall, that I’ve explained this before… But for those of you new to class… The Chinese renminbi’s Asian currency basket helps to set the price for the renminbi each day. The renminbi is allowed more flexibility to move versus the Asian currencies, so when we see the floating currencies like yen and Sing dollars moving higher versus the dollar, the renminbi has to move along with them.

I know I haven’t mentioned them lately, but the “fast track” currencies of Hungary, Poland and the Czech Republic continue to strengthen. These three were given the name the “fast track” currencies because about four years ago, it was thought that they had the “fast track” to join the euro. It has taken longer than observers first thought, as these countries work on aligning their economies and fiscal positions with the Maastricht Treaty, which dictates the requirements t 1. Join the European Union, and 2. Place your currency in the ERM II and 3. Convert to the euro.

The ERM II is the Exchange Rate Mechanism that is used to keep the currencies within trading bands to the euro. Should they not remain in those bands, they are bounced out. Remember when British pound sterling was bounced from the original ERM?

Currencies today: A$.7925, kiwi .7055, C$ .8620, euro 1.3220, sterling 1.9660, Swiss .8170, ISK 65.85, rand 7.1650, krone 6.09, SEK 6.9990, forint 192.60, zloty 2.9626, koruna 21.53, yen 119.30, baht 34.15, sing 1.5250, HKD 7.8130, INR 44.20, China 7.7415, pesos 11.12, dollar index 83.70, Silver $14.53, and Gold… $681.60

That’s it for today… I forgot to mention yesterday that I had a visit Sunday night from Allison Road! (My three-year old neighbor). What a sweetie… Ran to me, jumped on my lap and gave me a big hug! I’m outta here very early tomorrow morning, so Chris has the conn on the Pfennig until I get back next Tuesday. Here one day, and then out the door to Orlando for a company function the remainder of the week. So… Have fun, and I’ll talk to you next Tuesday! Have a great Tuesday!

Chuck Butler — February 27, 2007