Data Scorecard "Chuck Style"

Good day… I’ll lead off this morning with Chuck’s thoughts, as he did a good job of summing up the plethora of data we got yesterday morning. Here is Chuck’s wrap up:

“Oh where do I begin? The data was swirling around in my head yesterday. Good thing I’m off the pain pills! There’s just so much data to talk about, and I know it can be boring at times… But, we usually have one week a month that contains all these data releases, and I usually do my best to keep the boredom level low! So… Here goes!

“Batting lead off…personal income and spending. Both rose less than expected, the key here was that for once in a blue moon, we made more in the month than we spent! Unfortunately, that’s not what keeps the economy going, eh?

“Batting second…the personal consumption (PCE) deflator… Rose as expected 1.9%. This brings the YTD percentage just below the 1-2% comfort zone the Fed talks about. The Fed has come to love this piece of data, and if it’s below their comfort zone, there certainly won’t be any additional rate hikes.

“Batting third…home prices, as measured by Shiller/Case, fell 2.8% last month. Home prices continue to play a game of limbo, which is not going to play well with the home equity loan people, or those attempting to sell their homes to buy McMansions.

“Batting clean up…Chicago PMI (manufacturing) dropped more than expected in July. Usually, the Chicago PMI gives us a good indication of what the national manufacturing number as measured by the ISM Index will do.

“Batting fifth…U.S. Construction spending fell 0.3% in June.

“And in the RBI slot batting sixth…consumer confidence is soaring! Even with the credit crunch, hedge funds posting losses and folding, and all the other stuff I continually rant about forming dark clouds over our heads, consumers remain confident. As Billy Joel sang, “Don’t ask me why.”

“Oh… And this late addition to the batting order…. As usual, the media only picks up the core numbers, which take out food and energy. But here was the headline from MarketWatch…

“‘WASHINGTON – Core consumer inflation increased 0.1% for the fourth consecutive month in June, pushing the yearly gain in core inflation down to the lowest level in three years, the Commerce Department said Tuesday.’

“OK… That’s all fine and dandy if you don’t have to buy milk! Or any other food product, and the gas to get you to the grocery store! I say with milk above $4 a gallon, it is now cheaper than gas around here… I guess it’s time to drink gas!”

Thanks to Chuck for that great summary of the U.S. data released yesterday. Today we get MBA Mortgage Apps, Challenger Job Cuts, ADP Employment Change, pending home sales, ISM Manufacturing & Prices Paid, and Total Domestic Vehicle sales. I wouldn’t expect any of this data to be stellar, and the weekly pending home sales will likely show another drop, reminding the markets that the housing slump is still here.

That is what was so crazy about the rally in the equity markets earlier this week. I kept asking everyone on the desk, “What has changed?” We still have the housing slowdown, credit is still being tightened, and subprime losses are just beginning to show up. The move back into risky assets was, in my opinion, totally irresponsible. Just yesterday Bear Stearns announced they were halting redemptions from a third fund after investors demanded their money back. I continue to be convinced that the subprime woes aren’t over, and risks to the economy still remain. And the currency markets seemed to agree with me yesterday, as some of the high-yielders got beat back down last night as investors moved back out of these carry trades.

While the wide market was fairly steady, the Icelandic krona (ISK) was the big loser, reversing 2.5% of the gains it had made during the beginning of the week. This currency is the poster child for the carry trade, with the highest real interest rates in the world (12% interest less 3% inflation equals roughly a 9% real interest rate). As investors move out of the carry, this is one of the first currencies sold.

But the question remains, is the carry trade reversing for good? Or is this just another market gyration? Difficult questions which I don’t have answers to, and neither do the markets. Take a look at the recent headlines: “Yen Falls Against Euro as Stock Rally Spurs Carry Trade”; “UK Pound, Swedish Krona Fall as Investors Shun Risk, Exit Carry Trade”; “Yen Jumps Against Euro, Dollar, Pound as Carry Trades Unwind”. These were headlines released on Bloomberg within a few hours of each other. Everyone wants to blame the carry trade for just about every market movement we have; either the carry trade is going back on, or it is coming off. It’s hard to keep track. So what can you do to protect yourself versus the reversal of the carry trade? Buy Swiss francs (CHF) and Japanese yen (JPY). These currencies will rally as the high-yielders fall.

The Japanese yen continues to benefit from both carry trade reversals and the expectation that Japanese interest rates will rise. Household spending in Japan increased for a sixth month in June and the jobless rate fell, suggesting consumer outlays will help extend the economy’s longest postwar expansion. A report yesterday also showed that industrial output rebounded from a three-month slump in June. But figures released today also show that monthly wages dropped 1.1% from a year earlier, offsetting some of the good news on the consumer front. An August rate increase by the BOJ is still very much in question.

Both the Swedish krona (SEK) and Norwegian krone (NOK) were victims of unwarranted selling yesterday, getting caught up with their Nordic cousin the Icelandic krona. The Swedish krona declined the most in seven weeks against the euro (EUR) as global stocks tumbled and investors reversed carry trade positions. I have a hard time believing that the selling of these two solid currencies was warranted, and would look at this as an opportunity to buy. Sweden has a booming economy, which expanded 4.2% last year as consumer spending strengthened. The Riksbank said in June that it may increase borrowing costs again by year-end. The Norwegian krone is also a buy at these levels. With oil revenues at record highs, the Norwegian economy will continue to outperform the rest of Europe.

Another booming economy is one of our favorites from down under. Retail sales in Australia increased at their fastest pace in two years in June, providing further evidence that the central bank will raise interest rates next week. Sales advanced 1.4% from May, the first rise in three months. This stronger than expected growth in consumer spending follows reports yesterday that showed lending climbed the most in 18 years and housing approvals surged. Faster inflation in the second quarter and the lowest unemployment rate in 33 years have also stoked expectations of an interest rate increase. I continue to believe the Aussie dollar (AUD) will be somewhat insulated from the carry trade reversals, and should out perform the kiwi (NZD) over the next few months.

What do you think is the best performing currency among the 10 most active currencies traded in Asia this year? If you take away the Thai baht, which is no longer freely traded, it has been the Indian rupee (INR), which is up almost 10% since the beginning of the year. India’s central bank, which is not happy with the currency’s appreciation, had no choice but to raise rates yesterday to try and stem inflation. The central bank raised rates 0.5% yesterday and told lenders to set aside more cash to cover deposits. These moves are designed to drain liquidity from the credit markets and try to stem the inflow of capital, which is increasing inflationary pressures. India’s economy continues to grow at nearly 9% per year, second only to China in growth of the major Asian economies.

The problem the central bank faces is similar to what has occurred in New Zealand over the past few months. The central bank will raise rates to fight inflation, but also wants to limit the appreciation of their currency. They have been trying to do both by raising interest rates, while at the same time buying dollars and selling rupees to try and stem the rise of the currency. This can’t last; they just don’t have the deep pockets of China or Japan. I believe they will have to let the currency continue to increase, which is good news for the holders of rupees.

Currencies today: A$ .8507, kiwi .7605, C$ .9400, euro 1.3661, sterling 2.0257, Swiss .8311, ISK 62.69, rand 7.1484, krone 5.8521, SEK 6.7807, forint 184.87, zloty 2.7838, koruna 20.4970, yen 118.46, sing 1.5208, HKD 7.8292, INR 40.45, China 7.5725, pesos 10.9933, dollar index 80.77, Silver $12.7850, and Gold… $661.80

That’s it for today… Volatility is back in the markets, and makes the days go by quick on the desk. The best way to protect yourself in these volatile markets is to have a well-diversified portfolio, and to fight the urge to sell in a panic. Kristin came in early today; she has had a busy week so far, and has done a tremendous job handling all of the month-end currency trading by herself. Hope everyone has a great wired Wednesday, and welcome to August!!

Chris Gaffney
August 1, 2007