The Fearless U.S. Consumers

Good day. The data released in the United States yesterday morning surprised the markets on the upside, giving strength to the U.S. dollar. The consumer confidence number unexpectedly increased for a second month in July, as rising incomes and more jobs offset the impact of falling home sales. The Conference Board’s index increased to 106.5 in July, which is the highest in three months. That is up from 105.4 in June. A separate report from the National Association of Realtors showed sales of existing homes fell 1.3 percent last month, which was just as expected.

Just as they did last year, the U.S. consumers seem to be looking past all of the negatives and continue to support the economy. It looks like Chairman Bernanke was correct last week when he told Congress “Household spending will grow at a moderate pace as the real estate market cools.” So, it doesn’t look like we are going to get an abrupt end to consumer spending, but rather a gradual slowdown as the higher interest rates squeeze consumer’s wallets.

The dollar took these numbers and ran up, pushing the euro below 1.26 and the yen back up to 117.40. For the first time since Bernanke spoke, interest rate futures show traders see better-than-even odds that the central bank will raise its benchmark rate 0.25% on August 8, 2006. Depending on how the numbers look at the week’s end, the Fed will probably raise once more in August. But since this will be widely seen as the last move for a while, I would expect the dollar to start its slide as soon as the announcement is made.

Adding to the dollar’s strength was the fact that indirect bidders, a category usually seen as a proxy for foreign buyers including central banks, won 69 percent of $7 billion of 20-year inflation-linked notes the Treasury Department auctioned today. It was the highest percentage won by foreign bidders in any auction since the government began releasing data on bidders in 2003. So, the foreigners continue to have a need for U.S. debt, and the U.S. government is more than happy to sell it to them. We will see if they continue to have an appetite for the U.S. paper as the government auctions $22 billion of two-year notes tomorrow and $14 billion of five-year securities the day after.

I read where the tax receipts are coming in above expectations, so the U.S. deficits will be reduced (of course they don’t count the money spent in Iraq!). But these numbers reflect just how dependent we are on foreign purchases of our debt. China was just the latest in a series of foreign governments who have stated a need to diversify their reserves, and even though it hasn’t filtered through to the U.S. debt auctions yet, it will eventually. And what happens when we go to the market with an auction at which no foreign bidders show up? U.S. interest rates will be forced up, and the dollar will drop.

The slide in the euro was halted by reports from Germany and France. German consumer prices increased in July on the surge in oil prices. A 28-percent increase in the cost of oil in the past year is pushing up prices in Germany and other nations in the euro area, adding to inflation concerns at the ECB. Policy makers, including ECB President Jean-Claude Trichet, have signaled that they will raise interest rates as soon as next week.  French business confidence, which increased in July to a five-year high, also contributed to stopping the sell off in the euro. Economic growth in the euro area continues to pick up and the euro will continue to benefit from this growth.

One of our favorite currencies, the Australian dollar, rose to its weekly high overnight as speculation the central bank will raise interest rates next week pushed it up. The Aussie should continue to rally today as a report overnight showed consumer prices rose at the fastest pace in almost six years in the second quarter, breaching the central bank’s inflation target. Annual inflation is now running at 4%, well above the 2-3% band Reserve Bank Governor Ian Macfarlane is ordered to keep it within. This currency continues to be one of our “picks,” as the country enjoys good growth and relatively high interest rates.

The yen halted a two-day slide versus the dollar after a Bank of Japan policy maker, Miyako Suda, said the bank may lift borrowing costs a second time this year. Suda said it would be wrong “to determine there won’t be any rate increases” by the end of the year.  A government report showing Japan’s exports and imports climbed to the third highest on record, boosted optimism that the economy can withstand higher rates. While the timing of the next increase is in question, the direction of interest rates in Japan is not in question. Any increase in Japanese interest rates will have a positive impact on the Yen.  This currency should be one of the core holdings in investor’s portfolios. A good way to take advantage of the future moves in the yen is our new Orient Opportunity Index CD.  With a 3.8% APY for three months, this CD is an excellent way to hold the Asian currencies while receiving a good amount of interest income.

Currencies today: A$ .7583, kiwi .6248, C$ .8782, euro 1.2592, sterling 1.8410, Swiss .7988, ISK 72.73, rand 7.00, krone 6.30, SEK 7.34, forint 216.16, zloty 3.11, koruna 22.53, yen 116.88, baht 37.95, sing 1.5828, INR 48.80, China 7.9849, pesos 10.90, dollar index 86.54, silver $10.94, and gold $618.27

That’s it for today. Will be a pretty flat day with no real data to be released. The newest addition to the currency desk, Kristin Kuchem, is bringing in the Starbucks this morning.  Yahoo!! Wired Wednesday. Hope everyone has a great day.

Chris Gaffney
July 26, 2006