A Larger than Expected Cut

Good day… Wow did we ever get hit with a late winter storm yesterday! It snowed at a rate of up to three inches an hour throughout the morning yesterday for a total of 8 to 10 inches by the time we left for home last night. With yesterday’s snowfall, we have set a record for snow accumulation here in St. Louis over what has become a long winter.

With no data released yesterday, the currency markets took a much needed rest yesterday and stayed in a pretty tight range. The biggest news story was the half point cut by the Bank of Canada, which Chuck correctly called for in yesterday’s Pfennig. The new BOC governor, Mark Carney, signaled that further reductions would be needed to offset a slump in exports to the United States after announcing the biggest reduction in interest rates since 2001.

The loonie (CAD) held its ground after the larger than expected rate cut, as increasing commodity prices kept a floor under the currency. As we have warned in the past, the Canadian dollar looks like it will stay trading right around parity with the U.S. dollar, as both administrations seem happy with this level. With a majority of exports flowing south into the United States, I would expect the BOC to mirror any further rate cuts by the FOMC, and the loonie to stay stuck at the current levels for the near term.

The euro (EUR) eased back a bit versus the U.S. dollar overnight, retreating from a record high on speculation that ECB President Trichet will start trying to talk the euro down after it’s quick rise above $1.50. Several European finance ministers hit the speaking circuits yesterday voicing concern about the euro’s 16% gain versus the dollar in the past 12 months. Currency traders are expecting more ‘verbal intervention’ after tomorrow’s ECB meeting. The U.S. government’s ‘strong dollar’ policy is ‘very important,’ Trichet said in Brussels yesterday. Come on, he can’t really be serious can he? Trichet knows the United States has abandoned any hope of a ‘strong dollar’ policy!!

Chuck and I were talking yesterday about how the stronger euro will actually help the ECB reign inflation. Since oil is priced in U.S. dollars, the stronger euro will help bring down the relative costs of this precious commodity in Europe. Exports to the United States don’t have a dramatic impact on Eurozone GDP, as a majority of trade is within the continent so while some I don’t expect any of this strong talk to spill over to policy changes.

The ECB will continue to be focused on their fight against inflation, and will keep their interest rates unchanged at tomorrow’s rate setting meeting. This will contrast with the pro-growth, worry-about-inflation-later attitude of our FOMC, which will likely cut another 50 to 75 bps on March 18. Interest rate differentials will continue to keep the euro well bid and the dollar on a downward spiral.

The pound sterling (GBP) continues to come under selling pressure after a U.K. industry report showed that consumer confidence is weakening, reinforcing the case for the BOE to lower interest rates. The confidence number, which was released today, slipped to the lowest level in three years. I actually think the BOE will leave rates unchanged at their meeting tomorrow, but will continue to sound dovish in their statement, which will have the markets looking for further cuts. We continue to suggest that investors lighten up on any positions in the pound.

A currency to consider switching those pounds to is the Swiss franc (CHF), which turned in the best performance versus the US$ yesterday. Switzerland’s economic expansion accelerated to the fastest pace in more than two years in the fourth quarter according to a report released today. GDP in Switzerland rose 1% from the third quarter, when it grew 0.9%. The Swiss franc has been held down in value over the past few years by the carry trade, but has now started to make up some of the lost ground. Swiss interest rates, which continue to be very low, will continue to rise; further strengthening the franc.

The Australian dollar (AUD) sold off yesterday after a government report showed that the nation’s economy grew at the slowest pace in more than a year in the fourth quarter. Bank of Australia Governor Glenn Stevens signaled yesterday that interest rates might have peaked after the last increase. There are signs that domestic demand is slowing down, and the interest rate increases have had their desired effect. But even with a pause by Stevens, the rate differential with the United States will continue to widen as U.S. rates are lowered. This rate differential, along with strong commodity exports will continue to make the Aussie dollar one of the best performers in 2008.

Speaking of commodities, Chuck sent me a short piece on his thoughts on the reason gold continues to rise:

“Could investors be feeling more at ease, and with greater reason to hold hard assets instead of paper these days? And in hard assets, I mean gold! Now, we’ve never really been a ‘bond house’, but our metals trades far outweigh our bond trades these days… And I would bet that in brokerage houses across the country, they are seeing the same thing… That is if they had the chutzpah to go out on a limb and offer gold holding accounts!

“With the pressures on paper assets these days, and with the insurers that are supposed to be the backbone for bonds – but are instead flailing very awkwardly in the deep end of the pool – gold seems to be the investment of choice among individual investors. Now, the Big Boys and their bond desks can churn out bonds all day long every day, and I won’t argue that… But most of that business is institutional. I’m talking about me and you and a dog named Boo…”

As Chuck mentions above, interest in our MetalSelect accounts is about as strong as it has ever been. The gold-pooled accounts are the most efficient way I know of investing into either gold or silver. We also have the MarketSafe CDs in both gold and silver for investors who want to profit from the rising prices but don’t want to take any risk.

While the data cupboard was bare yesterday, we will see Nonfarm Productivity, Factory Orders, and the ISM service industry numbers released today. None of this data is expected to be positive for the U.S. economy, so the dollar will likely trade off throughout the day. And at the end of the day we will get the release of the Fed’s Beige Book, which is expected to show a further weakening of the U.S. economy.

Currencies today: A$ .9245, kiwi .7951, C$ 1.0074, euro 1.5190, sterling 1.9782, Swiss .9609, ISK 66.49, rand 7.7965, krone 5.1734, SEK 6.1621, forint 173.04, zloty 2.323, koruna 16.48, yen 103.87, baht 31.55, sing 1.3903, HKD 7.7893, INR 40.305, China 7.1088, pesos 10.707, BRL 1.672, dollar index 73.79, Oil $102.30, Silver $19.475, and Gold… $961.05

That’s it for today… Chuck and a couple of the guys from the sales desk head off to Florida this morning, leaving the rest of us to deal with the 10 inches of snow and freezing weather! The guys are heading down to Florida for an event that will reward them for all of the hard work they put in over the past year, and they really deserve the time off. The weather here just makes the trip even more rewarding! But with those three off the desk and John K. still in Mexico, the rest of us are going to have to pick up the slack, so I better get to work. Hope everyone has a Wonderful Wednesday!!

Chris Gaffney
March 5, 2008

The Daily Reckoning