Chris Gaffney

Good day. It was a warm walk across the bridge this morning, hard to believe we have temperatures in the mid-80s so early in the year. We usually get some odd days during March, which bring the temperatures up, but this summerlike weather has stayed for most of the month. It has certainly faked the plants out, as they are leafing out well ahead of schedule. Today, we will start to see if the nice weather we have had across the country has helped the housing industry. At least one Fed head is saying the warm weather is partially responsible for some of the recent gains we have seen in the economic data.

A chart of the dollar index for Monday looks almost identical to the chart from last Friday. The dollar fell dramatically just after New York trading opened, and then settled into a very narrow range for the rest of the day. The fall yesterday was sparked by the one piece of data that was released here in the U.S., the NAHB Housing Market Index, which indicated the housing recovery isn’t doing quite as well as most economists expected. While this index isn’t widely followed (I had never reported on it until yesterday), this week’s data are heavily skewed toward the housing sector, and many investors felt this index was a harbinger of more disappointing numbers over the next few days.

The largest move versus the U.S. dollar was made by the Swiss franc (CHF), which appreciated through a major technical level, triggering automatic orders, which fueled a further rise. The early morning move by the franc spilled over to the euro (EUR), which rose through its 100-day moving average. Neither Chuck nor I are big technical traders, but in lighter markets like we’ve seen the past few days, a breach of a technical level can lead to a larger currency move. Yesterday, both the euro and franc moved through levels that triggered stop orders. These are orders that currency traders place to “stop” them out if trades start to move against them, or to lock in gains after a certain price is reached. Both currencies held the higher levels they attained in early trading, which could mean further appreciation in the coming days.

A report out this morning showed U.K. inflation slowed less than forecast in February, rising 3.4% from a year earlier, compared with a 3.6% rise in January. The economists had estimated a 3.3% rise, so the drop from the month earlier didn’t have as big of an impact on the currency markets as it could have. The Bank of England has forecast price increases will subside in the coming months to settle in at its 2% goal for this year. But there is a good chance the slowdown in consumer prices will be reversed by the recent gains in the price of crude oil, which surged above $108 yesterday. This could force the BOE to cut the bond-buying program, which has been keeping rates down and supplying liquidity to the U.K. bond markets. The pound sterling (GBP) reversed a decline against the euro and the U.S. dollar after the inflation data was released.

The recent rise in the price of crude oil, combined with the positive economic news out of the U.S., pushed the Canadian dollar (CAD) to its highest level in almost six months. The Canadian dollar had not participated in the recent rallies of the New Zealand (NZD) and Australian dollars (AUD), as interest rate differentials favored the higher-yielding currencies of the South Pacific. But recent data out of the U.S. have investors pricing in a possible rate increase by the Bank of Canada later this year. Yields on the benchmark 10-year Canadian bonds have followed U.S. yields higher, adding 23 basis points in the past week, to settle at 2.24%. The rise in crude oil has also helped to push the loonie higher.

But news released this morning may lead to a further sell-off in the price of oil. Saudi Arabia’s cabinet stated in a report this morning that they would work with crude consumers and producers to restore “fair” prices. Crude prices could come under additional pressure tomorrow, as a government report tomorrow may show U.S. stockpiles rose to the highest level in six months last week.

This morning, as I turned on the trading screens, I noticed the dollar had all but reversed yesterday’s drop. The move higher came after BHP Billiton Ltd., the world’s largest mining company, said China’s steel production is slowing, damping demand for commodities. As usual, the markets ran with this indication that Chinese demand would not continue to increase. Didn’t I just report yesterday that the IMF was convinced the Chinese economy is heading for a soft landing? And yes, when an economy is slowing, all facets of that economy (including steel making) will slow. But commodity and currency traders are acting as if this news of lower demand out of China is surprising.

Both the Aussie and New Zealand dollars traded lower overnight, ending a nice three-day rally. The Aussie had traded higher after the publication of central bank minutes that showed officials had decreased their concerns about downside risks to the Australian economy. The minutes released yesterday showed Reserve Bank of Australia policymakers had discussed that while downside risks “could still materialize, this seemed somewhat less likely than a few months ago. So long as inflation remained well contained, there would be ample scope for the bank to ease policy in such a scenario.” Traders had been betting the Reserve bank would be cutting rates again this year, but the odds of another cut have not been reduced.

While many of the commodity-based currencies edged lower for the first time in a few days, the Brazilian real (BRL) has been dropping versus the U.S. dollar for three consecutive days. The real was the only currency that dropped versus the dollar in trading yesterday. Currency analysts lowered their forecast for the currency’s performance in 2012. The currency will end the year at a level of 1.80 real per dollar, compared against an earlier estimate of 1.75. The Brazilian government has staged a war against currency appreciation, expanding a tax on foreign loans and intervening directly into the currency markets. Brazil’s currency has dropped over 5% this month as policymakers have stepped up their dollar purchases. Inflation in Brazil remains within the government’s tolerance levels, with consumer prices in Brazil’s largest city rising just 0.1% in the past four weeks. Most economists are predicting interest rates will continue to fall as inflation remains subdued. The central bank cut rates 75 basis points in the first week of March, and the bank has signaled it is ready to cut an additional 75 basis points later this year. Investors have been attracted to the real by the relatively high interest rates and excellent currency returns, but as Chuck pointed out late last year, the Brazilian government seems hellbent on making the currency less attractive.

New York Fed President William Dudley threw a bit of cold water on the recent equity rally with a warning that the U.S. economy is still not on solid footing. “The incoming data on the U.S. economy has been a bit more upbeat as of late, suggesting that the recovery may be getting better established,” Dudley said in a speech yesterday. “While these developments are certainly encouraging, it is far too soon to conclude that we are out of the woods in terms of generating a strong, sustainable recovery.” Dudley attributed at least some of the recent gains in the economic data to unseasonably warm weather distorting YOY comparisons. He would not comment on the possibility of additional stimulus measures, but most of the stories I read on Dudley’s speech referred to his comments as being “dovish.”

Dudley’s prepared statement also correctly pointed out that much of the recent drop in the unemployment rate has been a result of a decline in the labor force participation rate. This rate of participation has declined to 64% from around 66% in 2008. While this 2% drop may seem nominal, it equates to a fairly large move in the unemployment rate. Without this drop in the participation rate, Dudley pointed out the unemployment rate in the U.S. would still be in the double digits. I admire Dudley’s attempt to temper some of the recent excitement regarding the ‘better than expected’ numbers. But you Pfennig readers know the actual unemployment rate is not in the lower double digits, as Dudley suggested, but is really over 20%. Our friends over at have all of the “unadjusted” numbers that show a slightly more negative picture of the U.S. economy.

To recap: The U.S. dollar dropped yesterday morning, but then reversed course today. The Swiss franc was one of the largest movers, triggering stop orders that sent it even higher versus the U.S. dollar. Commodity currencies sold off due to concerns over China’s growth (didn’t we just have confirmation that China was headed for a “soft” landing?). The Brazilian government continues to try to do everything it can to keep the value of the real down. And N.Y. Fed head Dudley shared a more pessimistic view of the current U.S. economy than what we have been hearing from the mass media.

Chris Gaffney
for The Daily Reckoning

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Chris Gaffney

Chris Gaffney is vice president of EverBank World Markets and the alternate author of the popular Daily Pfenning newsletter. Mr. Gaffney has been involved in the global marketplace since 1987, and is director of sales for EverBank World Markets. The Daily Pfennig is delivered via e-mail to tens of thousands of market watchers globally, providing commentary that allows them to stay on top of economic, currency, and market happenings. He is a Chartered Financial Analyst and holds degrees in accounting and finance from Washington University in St. Louis.

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