FOMC Sings the Same Old Tune
The dollar continued to gain strength throughout the day as investors waited on news from the FOMC. Overnight, Greece sustained another rate cut, this time by S&P, which caused investors to move back toward the ‘safety’ of the US dollar. The news caused the dollar to rally to a 3-month high versus the euro (EUR), and post gains across the board. The currency markets are becoming a bit volatile again, and much of this volatility can be linked back to the return of a transaction that dominated currency markets over the past decade.
The carry trade – where investors borrow at low rates and invest into higher yielding (but sometimes riskier) investments – has become popular again. This trade was extremely popular during the last few years, and helped push down the value of the Japanese yen (JPY) as it was the preferred funding currency of the carry trade. But as Chuck pointed out the other week, the US dollar has now replaced the yen as the funding currency of choice, as investors take advantage of the low rates here in the US to borrow funds and invest them into riskier assets. This is one of the factors that has been weighing on the value of the greenback. These carry trades use a high degree of leverage enabling investors to look for short-term trading gains. This leverage and short-term outlook makes the markets pretty volatile, as investors put on and take off the trades on an almost daily basis.
Overnight we saw the S&P downgrade Greece’s credit rating from A- to BBB+, matching an earlier move by Fitch. This move was largely expected, but it still shook investors’ confidence, as everyone is looking for the next downgrade. So the past few days have been ‘risk off’ days and investors moved monies back into US dollars. This move back into the dollar is a bit perplexing, as the problems facing Greece are the same facing the United States. As Chuck pointed out, California has a larger GDP than Greece and is in a lot worse financial position. But when you look at the information versus the explanation of the carry trade, the move makes a bit more sense. Investors see the downgrade of Greece as a possible precursor for additional credit problems and therefore took money off the risk table and back into the US dollar to sit and wait for another opportunity.
Chuck told readers yesterday that I would be reporting on Norway’s Norges Bank, and shared his thoughts that they would follow up on their previous hike of 25BPS with another hike of the same size. As usual, Chuck was bang on with his prediction, as the Norges bank surprised all of the non-Pfennig readers with a 25 BPS increase. Mike Meyer was putting some research together for Chuck, and also shared his research with me so I could include it in today’s Pfennig:
“In statements following the rate decision, policy makers commented that growth in private consumption is strong and home prices are rising sharply, so the bank considered the alternative of keeping rates unchanged, but said interest rates are low and the October increase had a limited impact on bank lending rates. The Norwegian economic recovery has gained steam since October’s policy meeting, but the market was assuming that fear of a perpetually higher krone (NOK) fueled by rate hikes would keep Norges Bank sitting on their hands until next year.
“The NOK is basically in a 3-way-tie with Brazil and Japan for third place over the past 6 months by posting about an 11% gain against the US dollar. Looking year-to-date, the krone has climbed up a bit to the number 5 spot and is currently sitting on a 20% return, which has led the exchange rate to trade close to the 5.50 handle during that period of time. In fact, it topped out at 5.5126 on 10/23, which are levels we haven’t seen in well over a year. Norway, the world’s 2nd largest natural gas and 5th largest oil exporter, suffered a milder recession than most industrialized economies thanks to its oil industry and stimulus measures employed by the government.”
Thanks to Mike for his excellent analysis of the NOK rate increase. While you would think a surprise rate increase would rally the NOK, the opposite occurred as the rate talk was overshadowed by the events in Greece. Norway has been plagued by worries about Baltic bank loans to weaker countries such as Iceland. But Norway still has excellent economic fundamentals, and continues to be one of the best-run economies in all of Europe. With a global recovery pushing oil prices higher, and interest rate differentials in Norway versus the US and Europe widening, the Norwegian krone should appreciate. I believe the current prices of the krone make it an excellent time to invest.
But lets move back to the US where the FOMC hit the repeat button and played the same old tune. As expected, Bernanke and his boys (and girls) kept rates unchanged and continued to tell the markets that rates would remain low for some time. The Fed continues to walk a fine line between trying to keep the stimulus measures in place, while sounding positive on the state of the US economy. Policy makers said the labor market is stabilizing (we will see the weekly jobs numbers this morning) but still kept a pledge to keep interest rates ‘exceptionally low’ for an ‘extended period’. The Fed did say most of its lending programs that benefited Wall Street dealers would end as scheduled on February 1 of 2010.
In addition to the weekly jobs numbers, we will see the release of the index of US leading indicators for November, which probably rose for an eighth consecutive month. Rising stocks seem to be bolstering consumer confidence even though unemployment remains in the double digits. A report released yesterday showed that the cost of living in the US accelerated in November from a month earlier, propelled by higher energy and medical costs. The 0.4% increase followed a 0.3% move up in October. The core index numbers (ex food and energy) were unchanged for the first time this year, throwing cold water on those warning of the inflationary impact of quantitative easing programs. But I am still of the opinion that these programs will bring higher inflation rates in the coming months. We may not see it immediately, but the amount of money creation that has occurred will (in my opinion) eventually filter into consumer prices. An extended period of extremely easy credit markets, along with the printing presses working overtime, has got to have an inflationary impact eventually.
Inflation certainly seems to be taking hold in India, where wholesale food prices rose tat the fastest pace in eleven years. An index of food prices increased 19.95% in the week following a 19.05% gain last week. Policymakers across Asia have started to exit monetary stimulus programs as their economies rebound. Rates throughout Asia will likely start rising, as inflation begins to take hold. This latest increase in food prices will put additional pressure on the Indian central bank to increase rates, which were cut in half over the past 12 months. The combination of a growing economy and rising interest rates should provide good support to the Indian rupee (INR) over the coming months. This currency, like the Norwegian krone, should be considered a good buy at current levels.
I’ll end today’s Pfennig with a rather humorous quote sent to me by Ty Keough. Fed Chairman Ben Bernanke’s confirmation hearing will start today in the Senate Banking Committee. And in spite of Ben being named Time’s Man of the Year, some believe he should not be confirmed as he has enabled the administration to put our future at risk by letting them run up record deficits. Ty came across the following quote on the Internet from a former member of our Armed Forces:
“I take exception to saying that Bernanke, Obama, and Pelosi are spending like drunken sailors.
“When I was a drunken sailor, I quit spending when I ran out of money.”