$100 Oil Is Here

Good day… Chuck left early yesterday and couldn’t make the call this morning. St. Louis has been hit with what is being called the worst flu epidemic in decades and it sounds like it finally caught up with Chuck. The dollar also continued to be under the weather yesterday, but rallied a bit overnight in front of the data we are expecting today.

Traders in Europe have begun rallying the dollar on the thought that today’s reports will show that U.S. inflation accelerated last month, giving the Federal Reserve less reason to lower interest rates. As Chuck touched on yesterday, we have a big day of data today with CPI, housing starts, building permits, and the FOMC minutes all being released. The CPI numbers are expected to show a 0.1% increase to 4.2% YOY while the core number is expected to remain at 2.4% YOY.

But after yesterday’s jump in crude oil to over $100 per barrel traders, are now beginning to bet January’s inflation numbers could surprise on the upside. We all know these ‘official CPI’ numbers the government continues to feed us are a bunch of bull, but I guess traders are figuring the government will have a harder time hiding inflation with the prices of oil and food rising so quickly. As we have been warning for sometime, inflation is increasing across the globe, and the price of crude oil drives price increases throughout the supply chain.

So predictions of higher inflation numbers have caused a mini rally in the U.S. dollar this morning, as investors lower their expectations of further rate cuts by the Fed. But this rally will likely be short-lived, as we will also see updated numbers on the dismal U.S. housing market released today. Housing starts in the United States have been predicted to remain near the lowest level since 1991, a sign the deepest real estate recession in a quarter century will weigh on the economy for a third year. A glut of unsold homes, mounting foreclosures and falling prices signal that the housing slump will continue putting pressure on the Fed to continue cutting rates.

So the big numbers being released today will illustrate the difficult position our current Fed head is in. The inflation numbers are likely to show rising prices, while the housing numbers will likely reflect the dismal state of the housing industry. Hopefully we will get a sense of how the members of the FOMC will deal with this conflicting data after the minutes of January’s FOMC meeting are released this afternoon. It will be interesting to see if anyone in the FOMC meeting at the end of January was at all concerned about the threat of inflation, or if the credit crunch and a possible drop in the stock market overshadowed all other concerns.

The Bank of England released the minutes of their February meeting this morning. These minutes showed that officials were actually discussing cutting 50 basis points versus the 25 basis points that they finally decided on. The release of these minutes combined with more dovish talk by BOE policy makers, caused the pound (GBP) to fall to the lowest level in a week against the dollar. BOE policy maker Kate Barker said the economy faces a greater threat from slower expansion than the risk of faster inflation. The weakest property market since 1992 and credit concerns will likely have the BOE continue to cut rates. Chuck warned investors to sell their pounds months ago, and with continued interest rate cuts, the sterling will likely continue to fall.

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While the BOE and the FOMC look to continue slashing interest rates, the latest data out of Europe shows why the ECB may buck the trend and hold rates steady. German producer prices rose at the fastest annual pace in 13 months in January. This data supports ECB President Trichet’s concerns that inflation is accelerating. The inflation rate in Europe has remained above the ECB’s comfort zone for some time, and with the recent jump in the price of oil, we don’t expect inflation to fall any time soon. The risk to the euro (EUR) has been the thought that the ECB may cave to pressure and cut rates in April or May, but this most recent data makes an ECB rate a little less likely.

The Brazilian real (BRL) strengthened to an eight-year high overnight as commodity prices continued to rise. We continue to favor currencies that export commodities, and Brazil continues to increase exports. Chuck had told readers about two recent discoveries of oil and gas deposits in Brazilian fields. One field alone is estimated to contain up to eight million barrels of oil, a little less than the entire reserves of Norway. The discovery of these fields has the potential to put Brazil among the world’s biggest oil producing countries. But oil isn’t the only commodity making the news in Brazil. Cia Vale do Rio Doce, the world’s biggest iron ore producer, yesterday won a 65% increase from the largest Asian steelmakers, reflecting rising demand for the main material used to make steel.

Interest rates also favor the Brazilian real. Brazil’s real interest rate, or the difference between the benchmark lending rate and annual inflation, is the highest in emerging markets, with Turkey having the second highest. In the United States, the real rate is negative 1.1%, so it isn’t hard to see why investors are looking at this emerging market for additional investments.

Increases in commodity prices will also support one of our favorite currencies, the Australian dollar. While Brazil is home to the world’s largest iron ore producer, Australia is still the main supplier of commodities to China, the world’s largest consumer of raw materials. The Aussie dollar also got a boost from a report that wages accelerated in the fourth quarter, increasing pressure on the central bank to raise interest rates as early as March.

Currencies today: A$ .9138, kiwi .7957, C$ .9823, euro 1.4655, sterling 1.9425, Swiss .9087, ISK 66.38, rand 7.8790, krone 5.3825, SEK 6.3590, forint 181.57, zloty 2.4476, koruna 17.27, yen 107.71, baht 31.58, sing 1.4139, HKD 7.8022, INR 40.20, China 7.1425, pesos 10.78, BRL 1.7419, dollar index 76.20, Oil $98.85, Silver $17.42, and Gold… $923.30

That’s it for today… Sorry this is a little late this morning; I am a little out of practice. The markets could be pretty volatile today with the release of big numbers in the United States. Got to get going, as I am way behind and we have a lot of work to get done. Hope everyone has a Wonderful Wednesday!!

Chuck Butler
February 20, 2008

The Daily Reckoning