US data baffling...

Good day….The dollar continued its ascent yesterday on productivity and service industry growth which again exceeded forecasts. Productivity, a measure of how much an employee produces for an hour of work, rose at an annual rate of 1.7 percent last quarter. The ISM followed up yesterdays strong manufacturing data with their non-manufacturing index which climbed to 56 in April from 52.4 in March. The data continued to confound economists and would indicate the US economy may be strengthening after the slowest pace of growth in four years.

But I don’t buy it, and after scanning several publications, I find I’m not alone in my skepticism. Yesterday’s headline in the Financial Times Market section put it best: “Strong US manufacturing figures are ‘baffling'”. According to the FT, “The rise in the ISM index is impossible to square with either the regional surveys released over the past few weeks or our medium-term, yield-driven model. We think it is quite likely that in their next iterations the ISM will drop sharply.”

Overshadowed by the strong ISM numbers were the weekly Initial Jobless Claims which did tick down, but remained above 300k. Continuing claims also dropped slightly. The markets focus is on today’s release of the Monthly jobs data as it will be the last major economic data release prior to the FOMC’s meeting next week. The bar has been set pretty low as the consensus among economists is for the monthly figures to show an increase of 100k. With all of the positive data released this week, and that wonderful ‘birth death model’, I think we will see the numbers come in just above the consensus at 107k. But even if the numbers come in as expected, the unemployment rate will tick up as 100k jobs won’t be enough to keep the rate at the current 4.4%. I continue to believe the FOMC has no choice but to leave rates right where they are and continue their ‘wait and see’ attitude. I don’t care what the data shows, the US economy isn’t anywhere near the bottom which we will likely see later this year or early 2008.

The good data continued the dollar’s bounce with the euro trading below 1.36 for most of the day and the yen hitting a two month low. The dollar’s rise was restrained by traders who want to wait and see if today’s employment data come in as weak as expected. If the numbers come in well above the expected 100k, the dollar could break out on the upside. But as I said above, I expect the data to come in pretty much as expected which will be weak enough to keep the dollar range trading until next week’s rate decision by the FOMC.

Chuck sent me a note from the conference he is attending this week and asked me to pass along his thoughts on recent events in China:

Here in Panama at the Sovereign Society Wealth Symposium I have heard many a conversation centering around China… What’s going to happen there? Will we place further tariffs on their goods, etc.

I’ve explained to everyone that as far as I am aware… There are currently 3 subcommittees from the U.S. House of Representatives that will hold joint hearings on Wednesday, May 9th, to focus on China… The discussions will center on to what extent not only China’s renminbi is undervalued as a result of the Government, but also Japan’s yen.

They will most likely come to the conclusion that these are “highly manipulated” currencies by each respective Government. Now here’s where it gets really meaty… The subcommittees, if finding the currencies are manipulated, will then discuss two things… 1. What further tariffs should be placed on their goods coming to the U.S. and… 2. why the U.S. Gov’t, namely the Treasury Dept., has not done more to rectify this situation.

Uh-Oh… That sounds to me like they are greasing the tracks for the protectionism measures that are already in the pipeline! I don’t need to tell you, or maybe I do… That currency participants do NOT favor protectionism measures! I would take these past couple of days, and any future ones we have before we get to May 9th, and use them as buying opportunities for the currencies, because if this all plays out, the dollar is going to be taken to the woodshed, and not just for a swat! Ok… Dollar go on out into the field and select the switch you wish to be beaten with!

US Treasury Secretary Henry Paulson has been making headlines lately preparing for his talks with Chinese economic leaders in Washington in three weeks. Yesterday Paulson called the low returns Chinese earn on internal savings ‘perverse’. He feels these low rates of return are one of the main reasons for the lack of consumption in China which has helped fuel their huge trade surplus. Paulson would like to see the Chinese leaders encourage consumption by their people. China’s savers are earning about 2.5% on their roughly $2 trillion in assets, even as the economy advances. That means savers must save more of their income, rather than spend, to meet their investment goals. China has a 50% savings rate, which limits domestic spending and leaves the nation reliant on exports. Paulson believes the biggest driver of the record US trade deficit with China is due to the ‘structure’ of China’s economy.

I have got to disagree with Secretary Paulson on this one. Yes, I would love to see China’s middle class become better consumers as even a small tick up in consumption would increase worldwide GDP. But don’t blame the trade gap on frugal Chinese consumers, the reason for the trade gap is right here in the good old ‘borrow and spend’ United States. Instead of preaching to other countries to be more like us, we should take a look at our own savings patterns. I don’t have the figures handy this morning, but I have got to believe the US has the world’s worst savings rate. Deficit spending is rampant, from the government right on down to the consumer. We continue to flood the world markets with US IOU’s, driving down the future value of our nation. I think Paulson should look to educate consumers right here in the US about savings rather than try and promote our bad habits onto others.

Another story caught my eye this morning and illustrates just how screwed up we are here in the US. The Federal Reserve is holding hearings on the sub-prime mortgage mess, and will likely set up a fund to ‘bail-out’ sub prime borrowers. Instead of letting these borrowers suffer the consequence of their poor choices, the congress has encouraged the Fed to let them off the hook. What kind of example does this give other borrowers? Our country has become so screwed up and dependent on deficit spending that we can’t let consumers suffer the consequences of borrowing too much. Why if consumers were actually made to pay all of their debts back they may have to save a little more and spend less; and what would that do to our economy? Maybe its because I was born and raised in the Midwest, but this leverage to the max attitude of today’s consumers just doesn’t make sense and in my opinion will contribute to a dramatic fall in the value of our US$.

One of our recent favorites, the Swedish krona fell yesterday as the markets prepared for the Central Bank’s decision on interest rates. Overnight, the Riksbank kept interest rates on hold, while saying it will raise rates faster than it forecast in February as wage growth threatens to push inflation higher. As readers will recall, Chuck disagreed with the Riksbank statement back in February that they would only raise rates once more this year. Well now they have had to rescind that statement and will likely be more aggressive with future rate decisions.

Robert Bergquist, chief analyst at Skandinaviska and former Riksbank official put it best yesterday “People still like the Swedish krona and think the fundamental picture is very strong, but are waiting for the Riksbank to signal that they’ll continue to raise interest rates”. Well now those investors have the green light as Riksbank has definitely indicated rates are going higher in the future. Swedish rates continue to be below those of its neighbor and trading rival Norway who last week decided (contrary to our thinking) to leave rates unchanged. We continue to view any weakness in this currency as a good buying opportunity and have included the currency in two of our Index cds, the Euro-Trax and Viking CDs.

Currencies today: A$.8187, kiwi .7338, C$ .9048, euro 1.3560, sterling 1.9867, Swiss .8225, ISK 63.69, rand 6.9868, krone 5.9921, SEK 6.7506, forint 181.80, zloty 2.7645, koruna 20.748, yen 120.35, baht 32.62, sing -1.518, HKD 7.8212, INR 40.91, China 7.7039, pesos 10.9037, dollar index 81.90, Silver $13.41, and Gold $682.52

That’s it for today…and for the week. The markets are waiting on the jobs data this morning, so we could have a volatile day. More rain here in St. Louis, it seems like it has been raining for weeks now! Hope everyone has a great Friday and a good weekend.

Chris Gaffney
May 4, 2007