U.K. Economic Data Boosts the U.S. Dollar

Good day… I want to start this morning’s Pfennig with a big congratulations to the MIZZOU Tigers who pulled off what most believed was an unlikely win over Memphis last night. What a game! They move on to the Elite Eight to play powerhouse UCONN on Saturday.

The currency markets weren’t as exciting as the basketball games yesterday, as the dollar held in a fairly tight range. The big move came in early morning trading as a report was released in the U.K. showing that their economy’s contraction was worse than previously thought.

GDP in the UK fell 1.6% in the fourth quarter of 2008 verus the previous quarter. And the outlook presented by the Bank of England is not rosy. BOE Chief Economist Spencer Dale said this morning that the British economy’s short-term prospects are ‘bleak’. Chuck has brought up the comparison between the U.K. and U.S. economies several times, as the U.K. economy looks like a mirror image (albeit smaller) of the U.S.’s. The U.K. economy has been slightly ahead of the U.S. in the race toward economic meltdown. Unfortunately the U.S. Fed seems to be shadowing every move by the U.K., cutting rates to near zero and then using ‘quantitative easing’ to force them down even further.

Both the U.K. and U.S. have been flooding their economies with liquidity, by purchasing their own debt. These moves are inflationary, and while we haven’t seen signs of any uptick in U.S. CPI, the U.K. inflation rate unexpectedly rose to 3.2% in February. An ominous sign for the U.S. economy. And by purchasing their own debt and forcing down interest rates below what the market is demanding, the U.K. and U.S. governments are pushing foreign investors away from the debt sales. This is one reason the failure of the Gilt auction – which I wrote about yesterday – is of so much concern to the United States. We rely on foreign investment in order to finance our deficits, but at the same time we are trying to force the interest rates at which these bonds are being sold to below what the market is demanding. This can’t continue, and it results in failed bond auctions. The solution? The currencies of the U.S. and U.K. will decline and interest rates will move back up in order to lure back foreign investors. This is inevitable, as the only way we can continue to run deficits while keeping interest rates low is to inflate our economies – which decreases the value of our currency.

The other economy to which the United States is constantly compared is that of Japan’s, which continues to be mired in an economic depression. Japan’s inflation rate was flat, and retail sales tumbled the most in seven years, signaling that their economy is heading back toward deflation. Prices in Japan were unchanged from a year earlier, and retail sales dropped 5.8% according to reports released last night. It now looks like Japan is back in the deflationary they have been working so hard to get out of.

Hopefully the United States can hit the sweet spot between these two ‘worst case’ scenarios: the inflationary spiral of the U.K. and the deflationary spiral of Japan. That is the goal of this administration, to hopefully stimulate our economy just enough to keep consumers spending, but be able to pull back this stimulus before it becomes inflationary. I certainly hope they will be able to accomplish this, but it is a tall order. Ultimately the United States needs to stop deficit spending and start saving. This is what will bring us back out of this economic quagmire.

Data released yesterday morning showed that the U.S. economy shrank slightly more than previously estimated in the fourth quarter. GDP fell 6.3% in the last quarter of 2008, just above the earlier estimate of 6.2% but better than economists had predicted. The markets largely ignored this dismal report and instead focused on the positive data released earlier this week. The equity market had another big day yesterday as investors seemed to feel that the worst was behind us and the first quarter GDP would show an improvement, or at least a stabilization in the U.S. economy. For all of 2008, our economy grew 1.1%, mostly due to government tax rebates.

A bigger reduction in inventories than previously estimated accounted for most of the GDP revision. The report showed that inventories fell 0.9% in February after dropping 1.1% in January, the biggest two-month slide since 2003. As Chuck explained earlier this month, these lower inventories are a double-edged sword. The decrease in inventories has brought the ratio of inventories to sales down for the first time in seven months. This ratio shows that manufacturers may have to start stepping up production to restock shelves. But it also increases the risk of higher inflation. Manufacturers are probably going to want to wait to see retail sales pick up before gearing up production. And with many factories idle and workers laid off, there will likely be a delay in getting production cranked up again. This delay could prove to be inflationary, as consumers are going to be met with empty shelves; too much money chasing too few goods is the definition of inflation. I’m sure Chuck will continue to watch this inventory-to-sales ratio for any early signs of inflation.

The euro (EUR) has come under some selling pressure this morning after European industrial orders dropped the most on record in January. Industrial orders fell 34%, the largest drop since records began in 1996. The drop emboldened those calling for the ECB to cut rates further to spur the economy. The ECB dropped rates by 50 basis points on March 5, and indicated that they would keep them stable for the immediate term. But the further decline in the United Kingdom and a deteriorating economic situation in the Baltic region has increased calls for further action.

The Norges Bank cut its key rate by 50 basis points yesterday and said Norway’s mainland economy (which excludes shipping and oil), will likely shrink 1% in 2009. The Norwegian krone (NOK) came under some selling pressure after the cut, selling off nearly 2% in the last 24 hours. A slight fall in the price of oil also weighed on the krone. Norwegian central bank Governor Svein Gjedrem indicated he has more room to cut benchmark rates if the global economic outlook deteriorates further.

This is a BLUE LIGHT SPECIAL on the Norwegian currency, and a great buying opportunity for anyone who was waiting to invest. Many feel Norway is the best ‘safe haven’ currency in the world, and their economic fundamentals are rock solid.

The dollar strength has stalled the advance of the Australian (AUD) and New Zealand (NZD) dollars, but they are still headed for their biggest monthly advance against the U.S. dollar in more than 20 years. The global equity rally has encouraged investors to start looking at higher yielding currencies again, with money moving out of the yen (JPY) and U.S. dollars, and  back into Australia and New Zealand. With both Japan and the United States using ‘quantitative easing’ to flood their economies with liquidity, the higher yields of Australia and New Zealand are attractive. The Reserve Bank of Australia is not even contemplating ‘quantitative easing’, indicating a healthier economy. Charts show that the Australian dollar will likely strengthen another 10% this year.

China continues to feel its oats in the run up to the Group of 20 meeting next week. Chinese central bank Governor Zhou Xiaochuan lambasted western governments yesterday, blaming them for not taking decisive action to combat the global economic slowdown. Evidence that China’s economy is starting to rebound has emboldened Governor Xiaochuan who called for a new international reserve currency to rival the U.S. dollar earlier this week. Premier Wen Jiabao started the rhetoric earlier this month when he said he was worried about the value of China’s $740 billion in U.S. Treasury holdings and asked for a guarantee of their safety. China is obviously working toward taking a much bigger leadership role at the G-20 meeting.

China’s economy has continued to grow, in spite of the global economic recession. The economy grew at 9% for all of 2008 after posting double digit growth in 2007. Chinese leaders have repeatedly stated a desire to keep growth above 8%, and indications are that they may be able to achieve these lofty goals. This is truly amazing, considering the Chinese economy recently surpassed Germany to become the third largest in the world.

We have repeatedly written about China’s rising influence on the global economy, and now they seem to be wanting a more dominant place at the table. Their $1 trillion in currency reserves has given them the right to take a more dominant role, and we are going to have to learn to deal with this more powerful nation. After all, they hold a majority of our IOU’s.

While I doubt if their calls for an ‘international reserve currency’ will get much traction at next week’s meetings, it definitely puts selling pressure on the U.S. dollar. Investors (both sovereign and individual) will continue to diversify their holdings, selling the U.S. dollar.

Currencies today 3/27/2009: A$ .6958, kiwi .5727, C$ .8106, euro 1.3400, sterling 1.4304, Swiss .8786, rand 9.54, krone 6.569, SEK 8.0960, forint 226.07, zloty 3.4218, koruna 20.317, yen 98.12, sing 1.5132, HKD 7.7507, INR 50.603, China 6.8324, pesos 14.2766, BRL 2.2488, dollar index 84.62, Oil $53.50, Silver $13.35, and Gold… 926.95

That’s it for today… What a night of sports in St. Louis last night!! I took my son to the Blues game, where we got to watch the new golden boy of St. Louis hockey, TJ Oshie score a remarkable goal. The Blues inched closer to a playoff spot, and have been playing some unbelievable hockey. We left the Blues game and got home in time to watch the Mizzou Tigers advance in the NCAA tourney. Just a great night for sports fans in St. Louis!! I just hope the weekend will bring us more good news for both of these teams. Speaking of the weekend, I just heard we may be getting a last push of winter weather through St. Louis with some calling for up to a foot of snow. Hope everyone has a Fantastic Friday, and a wonderful weekend!!!