GDP Disappoints

Good day…They tell me our email server is back up and running this morning, so hopefully this Pfennig will go out without a hitch. I’m a little worn out from celebrating with the 2006 World Champion Cardinals. What a season the Cards had! I’m sure Chuck will share his thoughts on the Cards season tomorrow, so I will move on to the economic news.

As Chuck wrote in Friday’s Pfennig, currency markets were dominated by the printing of third quarter GDP. The 1.6% annual growth rate was the slowest pace in more than three years, and less than the predicted level of 2 percent. Economists blamed the falling housing market for the drop. Homebuilding fell by the most in 15 years and the trade gap worsened as consumers bought more foreign-made goods.

The drop in energy prices has restrained inflation, and with this first estimate of third quarter GDP coming in weak, I expect the Fed to hold rates steady for the remainder of 2006 and into 2007. And in fact, third quarter GDP was probably even worse than described, as the report showed a gain in auto production which simply reflects a blow-out of 2006 models. Expect further weakening in the U.S. economy as the full effects of the Fed’s string of interest rate increases begins to be felt.

The U.S. consumer is still oblivious to the weakening economy. In October, consumer confidence in the United States rose to the highest it’s been in 15 months, as tumbling gasoline prices left more money in Americans’ pockets; money which they apparently ran out and spent on imported goods.

It is a scary situation that has developed. Foreign investors continue to buy up U.S. debt, keeping our rates low so U.S. consumers can purchase imported goods. Unfortunately these global imbalances can’t last forever, and the adjustments, which will eventually occur, will bring the value of the U.S. dollar down. It isn’t a question of “if” these adjustments will occur, but “when” (and I think we are getting awfully close to the start).

There will be a large amount of data released this week that should give the markets direction. Personal income, spending, and the PCE numbers will be out this morning. Consumer confidence and Chicago Purchasing numbers will be out tomorrow, followed by a whole plethora of sales and manufacturing numbers on Wednesday. The weekly jobs data will be released Thursday followed by the October labor reports on Friday.

The Yen finally started to move back up, hitting a one-month high over the weekend on speculation that the Bank of Japan report tomorrow will show an improved economic outlook. The BOJ will make their rate announcement tomorrow before releasing a semi-annual report that will outline the bank’s forecasts for prices and the economy. Governor Toshihiko Fukui and his policy board will likely leave interest rates unchanged and reiterate the need for a gradual lifting of interest rates. Currency traders are expecting the report to show an increase in the forecast for GDP, which may spur policy makers to raise borrowing costs by the end of the year. Any hint at higher rates before year-end should propel the yen back toward 110.

Other Asian currencies gained last week also, with the Thai baht rising to a seven-year high. Thailand’s central bank raised its growth estimate for next year to between 4.5% and 5.5% from a previous forecast of between 4% and 5.3%. It also lifted its prediction for export growth this year. While the gains in the Singapore dollar were met with possible intervention by their central bank, the Bank of Thailand governor said the central bank would let the markets do their job in stemming the rise. So it looks like we have a green light for further increases in the baht.

The best performing currency last week was the South African Rand, which benefited from an up tick in the price of gold and an expected increase in interest rates. Reports last week showed that consumer and producer inflation in South Africa accelerated at their highest levels in more than three years. This increase in inflation will likely cause the central bank to raise interest rates at their next meeting.

The Australian dollar also had a good week with several reports showing growth picking up in the Asia-Pacific regions. Retail sales rose 0.5% after climbing 0.3% in August, and building approvals started to rise again. Australia’s economy added more than 200,000 new jobs in the past five months, sending the unemployment rate to a 30-year low. Things continue to look up for the Australian dollar, a currency that continues to be one of our favorites.

Finally, India’s central bank will likely raise interest rates for a fourth time this year as record economic expansion and loans growth stoke inflation. Expect a quarter point increase in interest rates tomorrow, which should strengthen the rupee. Many reports are now expecting the rupee to strengthen to 44 by year-end.

Currencies today: A$ .7679, kiwi .6622, C$ .8913, euro 1.2726, sterling 1.9018, Swiss .8006, ISK 68.35, rand 7.466, krone 6.5434, SEK 7.2355, forint 206.41, zloty 3.05, koruna 22.27, yen 117.44, baht 36.76, sing 1.5605, INR 44.97, China 7.8738, pesos 10.76, dollar index 86.60, Silver $12.17, and Gold… $604.10

That’s it for today… What a weekend in St. Louis!! The Cards clinched the World Series on Friday, and the place has been going crazy ever since. After some tough weather last week for the games, this weekend was just amazing with 70 degrees and sunny for the Cardinal’s victory parade. Congrats to the 2006 World Series Champion Cardinals!! Have a great week.

Chris Gaffney
October 30, 2006