Dollar rallies on US manufacturing data...

Good day…The dollar bounced back up yesterday, recovering from its all time low vs. the Euro. The ISM factory index showed manufacturing in the US grew in April at the fastest pace in almost a year. This positive news overshadowed the pending home sales data which unexpectedly fell to the lowest level in four years. The data continue to illustrate the difficult position the Fed is facing and has focused the markets attention on Friday’s jobs report. Most, including me, believe the FOMC will leave rates unchanged at their meeting next week, but the mix of data which we have been seeing recently could force a switch in the stance in the policy communiqué.

As stated above, yesterday’s data showed orders jumped and production improved in April moving the ISM index to a higher than forecast 54.7. More importantly, the report shows inventories have continued to fall which is good news for the countries manufacturers. The markets used this positive data to offset another poor showing by the housing market. An index of pending sales of existing homes in the US fell to the lowest level in four years in March, confirming our belief that the housing slump has just begun. Putting the best spin possible on the day’s data, economists said strength in US manufacturing will pull the economy through the ‘slow patch’ which is being caused by the downturn in housing.

As readers know, we believe the ‘slow patch’ is going to be much longer than many predict. One month’s worth of positive manufacturing data doesn’t convince me the US economy is going to ‘pull through’ just fine. True, a weaker US dollar will help exports, but the US economy is mainly a consumer economy, not an exporter, so if the consumers start to tighten their belts (or are forced to) the US economy will continue to slow down.

Today we may see additional strength in the US$ as Factory Orders are reported for March. Orders are expected to have increased 2.2% in March after a 1% increase in February. Thursday we will get the weekly jobs data along with the ISM services report, but all of the markets attention will be focused on Friday’s monthly report of employment data.

So the data released today and tomorrow will likely be dollar friendly and extend the short-term rally which we have seen in the past 24 hours. But much like the rally we saw last week, this bounce is should simply be seen as an opportunity to increase positions in the core currencies.

I believe the markets are setting themselves up for a disappointment, as several economists have begun to use yesterday’s data as a basis to argue the US economy has hit a turning point and the second quarter growth won’t be as weak as expected. Unfortunately these economists are going to get slapped in the face by continued weakness in the housing market which will inhibit US growth throughout the rest of 2007.

European manufacturing expanded for a 22nd month in April as companies invested in equipment and hired more workers to meet export orders. European business and consumer confidence remains near a six-year high in April as unemployment dropped to the lowest since records began in 1993. The European economy’s growth trend is unabated and boosting the job market. This positive employment data will keep the pressure on the ECB to increase interest rates, narrowing the interest rate spread with the US.

ECB governing council member Klaus Liebscher wrote in a newspaper article yesterday that “Europe appears to be strong enough to cope with an economic slowdown in the US.” And the “vigilance of the governing council of the ECB helps ensure price stability and preserve purchasing power.” Price stability continues to be the focus of the ECB which continues to support the euro. The currencies of other central banks focusing on price stability have also benefited recently including the Pound Sterling, Australian dollar, and New Zealand dollar. These make up our Prudent Central Bank CD, which is the best performing index CD for 2007.

Australia’s central bank kept its benchmark interest rate unchanged last night as the economy’s 16-year expansion gathers pace without triggering inflation. Stable interest rates may spur consumer spending and revive a stalled housing market, stoking the economy’s expansion. Demand in Asia will continue to help Australia’s exports and keep the central bank’s focus on inflationary pressures. The Australian dollar has been one of the best performers of 2007, and relatively high interest rates combined with a stable economy should keep it among the top currencies.

Another commodity based currency, the Canadian dollar has stalled slightly after nearing an eight-month high as Bank of Canada Governor David Dodge said the currency was trading “higher than was assumed”. Dodge’s comments were a typical attempt at jawboning a currency down, and won’t likely have more than a very short term impact on the loonie. As Chuck reported yesterday, the Canadian economy grew twice as fast as expected in February. This good economic data will likely keep Canada from lowering interest rates which will continue to support the Canadian dollar vs. the US$.

The Japanese yen continues to fall vs. the US$ as reports showed wages continued to decline in March. Until wages begin to rise, consumer spending will probably lag, slowing the expansion of Japan’s economy. This data does not increase pressure on the BOJ to raise rates, so the carry trade is alive and well. The yen’s real effective exchange rate fell in April to a more than 21 year low according to the BOJ. The rate is derived by calculating the weighted average of the yen’s exchange rate against a basket of currencies used by Japan’s major trading partners. The result is then adjusted to account for inflation in those countries. The rate is useful for measuring long-term foreign exchange trends. The results are no surprise to investors of yen, the currency continues to trade at unreasonably low levels vs. the US$ and euro. Many are running out of patience with this currency, and I can’t blame them; but the best time to buy a currency is when its effective exchange rate is at its lowest point and the yen is now near its all time low.

Currencies today: A$.8245, kiwi .7377, C$ .8992, euro 1.3574, sterling 1.9907, Swiss .8214, ISK 64.04, rand 7.0413, krone 5.9839, SEK 6.7439, forint 181.68, zloty 2.7774, koruna 20.7201, yen 120.21, baht 32.65, sing 1.5262, HKD 7.8221, INR 41.19, China 7.7039, pesos 10.9288, dollar index 81.87, Silver $13.15, and Gold $671.63

That’s it for today… Chuck got out of town just in time as we are expected to have spring thunderstorms throughout the rest of the week. A good factory orders number in the US may extend this short term rally for the dollar, but treat it as a buying opportunity. The markets focus will remain on Friday’s employment data. Hope everyone has a great hump day!!

Chris Gaffney — May 02, 2007