G7 Takes It Easy On Japan…

Good day… And welcome to another week. The Money Show in Orlando was another good one, with crowds of people flocking to hear Frank and Chuck speak. I enjoyed working at the booth where I got to speak with several existing customers and educate new ones about the great services offered here at EverBank. I’m sure Chuck will want to share some of his thoughts on the Money Show, so I will just get on with the currency news.

The dollar has begun to rally in European trading this morning, as the currency markets digest a rather weak statement from G7. The only data due out this morning in the United States is the monthly budget statement, which is typically not a market mover. We will get the trade balance and ABC consumer confidence numbers out tomorrow morning, followed by MBA mortgage apps, advance retail sales, and business inventories on Valentine’s Day.

Thursday will be the big data day as the weekly jobs data will be joined by the empire manufacturing number, import price index, net long-term TIC flows, industrial production, capacity utilization, the Philly Fed index, and NAHB housing market index (whew, I got tired just typing all of that!!). Friday we will see January’s PPI, housing starts, building permits, and U. of Michigan confidence. With all of this data expected at the end of the week, I would expect some range trading today and tomorrow with the possibility of some volatility on Wednesday as Bernanke goes to congress.

The yen is the biggest mover this morning, trading close to another record low against the euro, after the G7 stopped short of saying its weakness is a threat to the global economy. So it looks like Paulson was able to convince his European counterparts to avoid tough talk on the yen. In fact, the communiqué released by G7 at the close of their meeting urged investors to recognize that Japan’s economic recovery is on track, and didn’t refer to the yen at all. Paulson continues to be one of Japan’s biggest supporters, as he continues to say that Japanese economic fundamentals set the yen’s exchange rate and that he trusts market forces.

As readers know, both Chuck and I also believe the markets should set the value of currencies, but allowing the yen and renminbi to continue to be dramatically undervalued is fueling huge global imbalances. Hedge funds and currency traders took this lack of focus on the yen by G7 as a signal to place more money into the carry trade. The Bank of Japan’s overnight lending rate is five percentage points lower than the benchmark in the United Kingdom and seven points lower than in New Zealand. This carry trade will continue to put downward pressure on the yen, while supporting some of these higher yielding currencies.

Paulson also sparked dollar buying as he said that a ‘strong dollar is in the interests’ of the United States, in an interview published in Germany today. This statement follows hawkish talk from several Fed heads last week, as St. Louis Fed President Poole said inflation that stays above 2% would be unacceptable and might require rate increases, while San Fran Fed President Yellen said the U.S. economy is on very solid turf and inflation is still too high. Bernanke will start two days of hearings in Congress on Valentine’s Day, and at this point it looks like he will continue to show the dollar bulls some love.

While the U.S. Fed members are starting to sound more hawkish, EU members have been raising the inflation warnings for a while now. EU Monetary Affairs Commissioner Joaquin Almunia said euro-area interest rates remain too low to rein in inflation, supporting ECB signals that they will raise rates again next month. This follows ECB President Trichet’s February 8 statement where he prepared the ground for another rate increase in March, vowing to show ‘strong vigilance’ on inflation, a phrase he has used to signal each of the ECB’s six rate rises since late 2005.

While the U.S. Fed is talking tough right now, I doubt if this talk will lead to any action in the near future. The ECB, on the other hand, is definitely going to raise rates again next month; so on interest rate differentials alone I would think we would see the euro move strongly above the 1.30 level.

China’s trade surplus widened to $15.9 billion in January, as exports gained by the most in 17 months, adding pressure on the government to let the yuan rise faster. The gap, reported by the customs bureau on its website today, welled by 65 percent from a year earlier. It was the fifth highest on record. While G7 gave a free pass to Japan, they did criticize China for keeping the renminbi down in value. It looks like officials in China ignored the criticism, as they pegged the renminbi at 7.756, the largest drop in a month. Chinese Central Bank Governor Zhou Xiaochuan said the pace of gains is ‘appropriate,’ suggesting China is unlikely to allow the currency to rise faster.

Currencies today: A$ .7735, kiwi .6845, C$ .8523, euro 1.2954, sterling 1.9475, Swiss .7976, ISK 68.20, rand 7.29, krone 6.249, SEK 7.03, forint 196.63, zloty 3.03, koruna 21.86, yen 121.90, baht 33.70, sing 1.5385, HKD 7.8137, INR 44.16, China 7.756, pesos 11.028, Silver $13.80, and Gold… $664.25

That’s it for today… I made it back from sunny Orlando late Saturday night and got to spend a nice day with my family yesterday. Chuck stayed down in Orlando and will make the short trip up to headquarters in Jacksonville for a series of meetings today. He returns home tonight and will bring you the Pfennig in the morning. Hope everyone has a great start to their week!

Chuck Butler —  February 12, 2007