Leaving Rates Unchanged

Good day… The dollar continued to slide yesterday and got hammered overnight in Asia and Europe, as both the ECB and BOE left rates unchanged. After very little data in the U.S. markets over the past two days, today and tomorrow will bring big employment numbers along with a better look at how the U.S. consumers are feeling. None of this data will be supportive to the greenback, so look for more record levels for the currencies versus the U.S. dollar.

As you all know, Chuck is down in Florida for a company event this week, but his eye is always on the market and he sent me the following late last night:

“From my view in the cheap seats… The dollar got pummeled again yesterday, especially after the Fed’s Beige Book came out, and caused a V-8 moment for traders. The V-8 moment was all about the fact that the Fed is spooked – as they very well should be – and as such, they have stopped drinking the Kool-Aid from last summer that said this would all blow over. The fact is, they are cutting rates, come hell or high water; and in this case the ‘high water’ is inflation. And then it hit the traders once more… Whack! These interest rates differentials for the dollar are going to send it to the woodshed! And… So it did!

“Yesterday on my drive to the airport, I heard that ’80s song, Final Countdown… It’s the final countdown… OK, if you’re from that era, you’re singing along right now… I wasn’t… I’m a flower child of the late ’60s and early ’70s, but my good friend Rick is a child of the ’80s, so he’ll love the fact that I mentioned an ’80s song! Anyway… The song got me thinking that we’re in the Final Countdown to this week’s European Central Bank (ECB) meeting, in which the markets are getting prepared to hear hints from ECB President Claude Trichet.

“I like to use the term ‘opening Pandora’s Box’ when describing things, and have done so since I started writing this newsletter in 1992. I don’t know if Trichet is going to ‘open Pandora’s Box’ of easing expectations just yet. Maybe he will… But… He has talked for so long about the economic strength in the Eurozone, that to pull the rug out from underneath that talk now, might be a bit too much to expect. But then… I’ve had the rug pulled out from underneath me before by a central banker or two… So… There you have it… My views from the cheap seats here in Clearwater, Florida, where, being outside tonight isn’t exactly ‘warm’!”

As I said up front, the Bank of England was first with their interest rate announcement this morning and they left interest rates unchanged as accelerating inflation prevented policy makers from cutting borrowing costs to shore up economic growth. Some had thought we would see them cut again, so the pound (GBP) popped back up above $2.00 after the news. I would look at this as an excellent time to lighten up on your pound sterling holdings, as home values continue to fall in the United Kingdom, which may put additional pressure on the BOE to cut rates in the future.

The ECB was next up to the interest rate table and they also left rates unchanged. Like the BOE announcement, this non-move was widely expected, so it shouldn’t have much impact on the currency markets. As Chuck discussed above, the markets are waiting to see what Trichet says after the announcement. He has been holding to his ‘anti-inflation’ stance through some pretty tough times, so I don’t expect him to change right now. However, he recently started to talk about the slipping U.S. dollar, and with the euro (EUR) hitting a record high, I’m sure he will expand on these recent statements. Trichet has the advantage of holding the high ground in the war of words with the FOMC, as he has been the more prudent central banker and his economy is reaping the benefits of this.

Bernanke and his compatriots look like dolts right now, after throwing inflation worries out the window and cutting rates in an attempt to bail out those on Wall Street who made horrible investments. The interest rate cuts by our Fed have not improved our economy and have in fact sent us down a very scary path of higher inflation with little or no growth (STAGFLATION). Yes, these rate cuts have helped to keep the equity markets from falling dramatically (for now), but is that what the Fed should be focusing on? I say no! Our Fed should have been keeping an eye on inflation and let the markets punish those who made these horrible investments. Yes, it would hurt some in the short run, but by cutting rates they have only put off the inevitable, as they have backed themselves into a corner with no where to run.

The weekly employment data released this morning will give us a better picture of the U.S. economy. Economists are predicting a drop in the weekly jobless claims, but after yesterday’s private sector employment report, many are now questioning this rosy outlook. We will also see the pending home sales number and ICSC Chain Store sales later this morning, neither of which look promising for the U.S. economy. Tomorrow we will get the more important monthly jobless numbers, which are expected to show a tick up in the unemployment rate to 5% from 4.9%. Consumer credit will also be released tomorrow, and is expected to show that consumers went more in debt during January. None of these numbers will be positive to the U.S. dollar.

Another rate announcement occurred last night, as the RBNZ left rates unchanged. Chuck had this to say: “The Reserve Bank of New Zealand (RBNZ) left their rates unchanged, and their statement following the announcement was hawkish, which ‘surprised’ the markets after hearing and believing the smoke screen the RBA put up the other night. The RBNZ is very concerned with inflation risks. They admit to seeing the economy slow down, but to them (and don’t you just love this?) right now, they feel that fighting inflation is more important than economic growth.”

Chuck is right on with his assessment, as RBNZ Governor Bollard said that he would likely leave rates at their record level well into 2009. As many readers know, Bollard’s pay is based on his ability to keep inflation within a specified band (a great way to make sure his focus remains on inflation!!). Record low jobless rates and the promise of income tax cuts this year will likely fan inflation, so the central bank is being proactive to stay out in front of the curve. The kiwi (NZD) will remain very popular with investors looking for additional yield in a solid economy.

Two other economies that continue to perform well due to the rise in commodities are Brazil and Australia. Brazil’s economy is expected to grow 4.5% this year and Australia 3.4%, while the United States will expand at just 1.8% (and I question that figure) according to median forecasts of economists in Bloomberg surveys. These economies will continue to benefit from commodity exports and their currencies should benefit from these high rates. Interest rate differentials will continue to be the story driving currency markets, as investors will be selling U.S. dollars and buying higher yielders. This was called the carry trade when it involved the Swiss franc and Japanese yen, but as Chuck pointed out last week, the funding currency for this carry trade looks like it has now moved over to the U.S. dollar. Not good news for the greenback.

Speaking of commodities, did you see the spike in the price of oil? At over $105, crude oil is now at a record level, even after adjusting for inflation. Gold and silver are also benefiting from record inflation as investors flock to these ‘hard’ assets to offset expected inflation. Nothing in the near future looks to reverse this recent trading pattern, so I expect these commodities to continue to climb into the stratosphere.

Currencies today: A$ .9376, kiwi .8036, C$ 1.0157, euro 1.5327, sterling 2.0004, Swiss .9684, ISK 66.27, rand 7.7852, krone 5.1103, SEK 6.1045, forint 171.60, zloty 2.306, koruna 16.38, yen 103.52, baht 31.54, sing 1.3859, HKD 7.7878, INR 40.2325, China 7.1061, pesos 10.709, BRL 1.6595, dollar index 73.22, Oil $105.73, Silver $20.865, and Gold… $987.70

That’s it for today… Busy day on the trading desk yesterday. The recent market movements have put record call volume into our queue, so if you are trying to call the desk please be patient. Weather is much better today and they have finally got the snow cleared off the roads, but we are expected to get another hit of winter tonight. Hope everyone has a Tremendous Thursday!!

Chris Gaffney
March 6, 2008