U.S. Trade Gap Narrows

Good day… As Chuck signed off on Friday, the dollar had dropped to the lowest level in over two years versus the euro based on expectations that the trade deficit was going to show it widened in February. But the predictions were wrong, and the dollar quickly turned around and rose, as the report showed the United States purchased fewer goods from China and imported less petroleum.

The gap in goods and services narrowed to $58.4 billion from $58.9 billion in January. This dollar strength didn’t last over the weekend though, as the lack of action by the G-7 pushed the euro right back up over 1.35 this morning.

Separate reports on Friday showed that prices paid to U.S. producers rose more than forecast in March, led by higher energy costs. The core rate, however, was unchanged after rising for four straight months. So the data really didn’t change the outlook for inflation in the United States.

The report shows steady pressure on prices at the wholesale level, but core inflation seems to be moderating. So as long as you don’t have to eat and drive, inflation is not a problem!!! That is what is so wrong about reporting inflation without looking at the entire picture. I know that the “economists” say food and energy are so volatile that they would make the numbers too unpredictable and could scare the bejeebers out of anyone who follows them. Well the true inflation picture does include food, energy, healthcare and education costs and any consumer could tell you inflation is running much higher than the “core” numbers show!

An interesting fact that I pulled out of the deficit report was that China has now become the largest shipper to the United States. Up until last month, the U.S. had imported more goods from our neighbor to the north than from any other country. But with $48.7 billion worth of goods sold to the United States in February, China has overtaken Canada as our biggest shipper. But unlike Canada, China doesn’t seem to be playing fair. No doubt, this data will be used as fodder for more protectionist calls from our buddies Graham and Schumer.

As Chuck pointed out on Friday, China did not attend the G-7 meetings held over the weekend. I guess they didn’t feel like flying to Washington D.C. for some good meals and major spa time – and after reading the communiqué that was produced following the meeting, it looks like that is about all the other attendees did. The finance chiefs from the G-7 nations didn’t call out Japan…or hedge funds…or the carry trade. They didn’t do anything! Why meet? Just a boondoggle!

And just what did they have to show for the three days of meetings? They said that demand in Asia and Europe is strong enough to offset a slowdown in the United States. An increasingly even pattern of growth will ease trade gaps and extend the strongest world expansion since the 1970s. They are confident that a slowing U.S. economy and increasing consumer demand by a burgeoning middle class in Asia will take care of all of our global imbalances. Yes, just sit back and do nothing and everything will work out on its own. Sounds like they spent a little too much time relaxing in the steam room!

Since the G-7 meeting turned out to be a non-event, currency traders took the euro back up versus the dollar and yen. The euro also benefited from ECB policy maker Guy Quaden, who said that another interest-rate increase was “likely.” “A new increase in our rates in the coming months is possible and even probable,” Quaden said yesterday. “It’s in fact the most likely scenario.”

Inflation in the euro area accelerated in March as energy prices rose, bringing the rate closer to the ECB’s 2% ceiling. Consumer prices in the 13-country euro area increased 1.9% according to a report released this morning. With a growing economy and interest rates looking like they will continue to rise, the euro could touch 1.40 by year-end.

The pound sterling rose to its highest rate against the dollar since September 1992, as traders bet that the minutes from the BOE’s April 4-5 meeting will show that policy makers are leaning toward further rate increases. The pound hit $1.9940 – its strongest since September 9, 1992 – and U.K. factory prices rose the most in 11 months in March, as companies passed on higher raw material costs to customers, feeding inflation pressures into the economy. Adding to inflation fears, a report showed that London housing prices rose the most since 2004.

On Friday, Chuck pointed out a move back toward risk, which has been occurring for the past few weeks. This move back into the carry trades has helped the high yielding currencies, and has continued to hold the Japanese yen and Swiss franc down. And while the Japanese central bank seems quite content with the undervaluing of their currency, the Swiss don’t seem so complacent.

Swiss Central Bank President Jean-Pierre Roth said the franc’s 2% drop this year versus the euro wasn’t in line with the country’s economic fundamentals. The Swiss franc is substantially undervalued, and the central bank looks like it is ready to raise interest rates to try and bring the value of the franc back in line with fundamentals. Unfortunately, until the “carry trade” starts to unwind, their efforts may prove fruitless. But strong economic fundamentals and a central bank that actually wants the currency to properly reflect this strength should bring the value of the Swiss franc up.

So it looks like a continued drop for the dollar today. We will see advanced retail sales, empire manufacturing, Net TIC flows, and business inventories today. The TIC flow data will be the market mover, with the United States needing to continue to attract foreign purchases of our securities in order to support our trade deficits. The February Net Long-term TIC flows are expected to have dropped to $76.5 billion from $97.4 billion in January. This data should not be dollar positive, and a further sell off is likely.

Currencies today: A$ .8336, kiwi .7403, C$ .8835, euro 1.3561, sterling 1.9919, Swiss .8251, ISK 65.25, rand 7.1220, krone 5.966, SEK 6.804, forint 180.82, zloty 2.8197, koruna 20.625, yen 119.52, baht 32.60, sing 1.5131, HKD 7.8133, INR 42.035, China 7.7331, pesos 10.97, dollar index 82.029, Silver $14.08, and Gold… $687.55

That’s it for today… Don’t forget to mail your taxes (if you haven’t already!) I owed a little this year, so mine are going in the mail today, it just feels better keeping the check out of the governments hands as long as I can. My back is a little sore this morning as I spread 11 yards of mulch into the beds around our yard this weekend. It looks like spring is finally back here in St. Louis! Have a great start to your week!!

Chris Gaffney — April 16, 2007