Caught Between a Rock and a Rock!

Good day… I trust your St. Patrick’s Day celebrations were good. Mine was low key at best, but that’s OK… It’s a great day to be Irish! Hope your NCAA brackets weren’t as damaged as mine! Friday was another day of data in the United States and once again the markets swept the results under the rug, as all market participants have been glued to the screens waiting for the next news story on the subprime mortgage meltdown.

First, let’s review the data from Friday. CPI (consumer price inflation) ticked upward, thus keeping the Fed Reserve wedged in between the rock…and well…another rock. The seasonally adjusted all-items CPI increased 0.4% in February, beating the market forecast for a 0.3% gain in the index. The CPI, excluding food and energy, advanced 0.2%, which was bang on the expectations. Relative to a year ago, the all-items CPI rose 2.4% in February, faster than January’s 2.1% pace while the core CPI held steady at 2.7%.

You know me… I don’t agree with the results of this data due to the moving goal posts inside the data configuration. And furthermore, I do not care what “core” inflation is. Give me the whole picture, because that’s what I have to live with every day! Ok Chuck, slow down, it’s only Monday, no need to get all fired up on a Monday!

Industrial production for February rebounded from the previous month’s awful showing… But you know me… Average them out, and you’ve still got some tepid industrial production. Here’s the report card: Industrial production rose 1% in February, more than reversing January’s revised 0.3% dip and beating the “experts” forecast of just 0.3% growth. And then one of my faves… capacity utilization rebounded to 82% from the revised 81.4% rate in January. Still far below the go-go days of the late ’90’s… But better. And that’s a good sign for the economy.

However, there are just not enough of them! I think consumers are beginning to feel the pinch too! The U. of Michigan consumer confidence showed some souring of consumers’ confidence in the early part of this month. The index slipped to a six-month low of 88.8 from 91.3 in February. The dip was larger than the “experts'” estimate for a 1.3 point reduction to 90.

Ok, so… With inflation edging up, along with industrial production, the markets should have been excited and all lathered up over the prospects for strong growth. The dollar especially should have had a spotlight affixed on it. But NOOOOOO! As I told you on Friday morning, the markets have become very myopic on this subprime mortgage meltdown. So, if they are going to focus on it, we had better do so too! Of course, I could talk about how I was pointing out the dangers that were be created by the creative financing in mortgages for a long time before this meltdown began… But I won’t! No wait, I did! I did! I did see a putty tat!

My friend, John Mauldin, has been on top of this meltdown with some great insight and data, so let’s take a look at what John had to say in his Friday letter last week…

“Subprime mortgages were about 20% of the market in 2005-2006. Already almost 12% of those mortgages are in some part of the foreclosure process, with anecdotal evidence that the number is going to increase. The prediction late last year by the Center for Responsible Lending that as many as 20% of the subprime loans made in the last two years would end in foreclosure does not look as Cassandra-like when it first was made. The CLR study suggests that as many as 2.2 million people will lose their homes.”

And here’s my two-cents added to what I’ve already said about this meltdown… The number of loans made in the past few years that have required “no documentation” is astonishing! There are reports out that up to 60% of subprime loans that were made in the past few years were done with “no documentation”. That means, the borrowers were most likely overstating their incomes so that they would qualify for a larger loan. Uh-Oh! When the re-pricing is done on the subprime ARMS, these borrowers then can’t make their payments.

This causes two problems to the economy: First, all these houses go back on the selling blocks, thus bringing down the values of everyone else’s homes, thus causing problems with the ability of these borrowers to obtain Mortgage Equity Withdrawals (MEW’s). And second, lenders are going to – if they haven’t already begun to do so – tighten down the hatches on the “easy credit”, thus closing the door on borrowers who would have qualified for a loan previously, thus keeping those homes that just got put back on the selling blocks, unoccupied!

As I’ve said before, the tentacles of this subprime mortgage meltdown will go deep into the fabric of this economy, and most likely will be the key master for a recession.

But don’t look for any help from the Fed Reserve. As I keep telling you, they are wedged between a rock and an even harder rock! They can’t raise rates to fight rising inflation, because of the housing mess, and they can’t cut rates to help the housing mess, because of the rising inflation. Oh, well, they made this bed… They can now sleep in it!

The euro spent most of Friday and the overnight session last night above 1.33. But as I glance at the screens, I see it has come back below 1.33. No worries on my part! I have a saying… Buy on the dips… And while this isn’t a big dip, it is a dip!

In Asia… China raised interest rates again in an attempt to cool the economy… I know the Chinese have been banking longer than us… So why are they following the Fed’s small rate hikes practice that didn’t work here? Anyway… The renminbi hit another record high since the dropping of the peg versus the dollar in the overnight session.

The Singapore dollar continues to move higher versus the dollar along side the renminbi, as I thought it would do. The killer in Asia has been the Thai baht. Up over 15% this year, even after the military government placed currency controls on the baht, and locked us out of the market.

Japanese yen weakened overnight back above the 117 handle. In recent trading sessions, the yen has flip-flopped back and forth over that 117 handle. Japanese officials are worrying about yen getting too strong as carry trades begin to unwind. So… What do they do? They jawbone it lower. Bank of Japan (BOJ) Governor Fukui let it be known that the BOJ members aren’t in any hurry to raise interest rates. UGH! LIARS!

Oh, well… In keeping with my “buy the dips”, Mr. Fukui has afforded us that opportunity, eh?

The Nordic currencies of Sweden, and Norway, are both back to gaining versus the dollar, stealth like. Interest rate hikes here have put these two currencies in a position to compete with Swiss francs as “euro alternatives”.

And look at those South Pacific beauties. OK, you know I’m talking about Aussie and kiwi. Aussie is within spittin’ distance of 80-cents, and kiwi just crossed the road to 70-cents! I’m not as wild about owning kiwi going forward as I am Aussie, due to the possibility of carry trades unwinding, and traders refocusing on New Zealand’s debt picture. But for now… Let’s party in the South Pacific, eh? And on that uplifting note, I’ll head to the Big Finish!

Currencies today: A$ .7980, kiwi .70, C$ .8505, euro 1.3295, sterling 1.9440, Swiss .8255, ISK 67.05, rand 7.4380, krone 6.12, SEK 6.99, forint 185.25, zloty 2.9140, koruna 20.90, yen 117.25, baht 32.80, sing 1.5260, HKD 7.8120, INR 44.07, China 7.7360, pesos 11.16, dollar index 83.41, Silver $13.15, and Gold…. $654.91

That’s it for today… Spring begins this week. YAHOO! It was a cold St. Patrick’s Day here in St. Louis, let’s hope spring brings us some warmer weather! Chris begins his spring break today, but is going to be my savior Thursday & Friday, as he will have the conn on the Pfennig, I’m heading out to Jupiter, on Thursday, for my spring vacation. What a trooper! Bring on that spring! Have a great Monday!

Chuck Butler — March 19, 2007