A Reversal of Fortune…

Good day… I hope your weekend (which, for me and quite a lot of others, was a three-day weekend) was grand! The weather here was awful, but it’s winter. This is more like the winter we’re used to experiencing here in St. Louis, which makes my trip to Orlando for the World Money Show in three weeks even better! We’ve had two economic reports this morning from Europe that, in normal trading times, would have propelled the euro and sterling higher versus the dollar. But these aren’t normal trading times… So, let’s go to the tape and see what’s happened!

First off… Friday’s retail sales here in the United States showed a nice strong Christmas shopping season. Retail sales for November were revised down a bit, and December’s sales increased 1%. The markets went bananas over this number, and the dollar was bought up like Cabbage Patch Dolls (80’s), Tickle Me Elmos (90’s), and X-Box 360’s (2000’s)… You get the picture.

But could I interject something here about retail sales that I think the markets have seen go right over their heads… IT WAS CHRISTMAS! RETAIL SALES SHOULD HAVE BEEN STRONG! And… One hangover from all this “shopping” will be increased credit card debts. But don’t let that get in the way of a “feel good story.” Oh… And don’t forget one little thing…strong retail sales equals a higher trade deficit. Watch for it.

OK, so the dollar got bought up like no tomorrow after the printing of retail sales, but then a reversal of fortune came about, and when I turned off the screens Friday afternoon, the euro had actually reached a higher level versus the dollar than when I came in that morning! Had the euro reached an “oversold” position? I think so!

Yesterday, there was little volume with the U.S. markets closed, but we did see some additional improvement in the euro and other currencies as the day went along. This morning though, we’ve seen a strong German ZEW and a higher than expected U.K. inflation report, which should indicate even more improvement in the euro, sterling and other currencies. However, the markets have been a little strange lately reacting to data like this from outside the United States. So, I guess we’ll have to see, eh?

German investor confidence, as measured by the think tank ZEW, rose to a six-month high this month. That’s a great performance given the fact that these same surveyed investors have to deal with a 3% VAT (tax) that was added on January 1. Maybe the markets are waiting to see if the business sentiment, as measured by the think tank IFO, will be strong too, before they push the euro higher. The IFO report will print next week on Jan. 25.

In the United Kingdom this morning, we saw a report that puts inflation at the highest level in over a decade, at 3%. This report certainly gave credence to the Bank of England’s (BOE) surprise interest rate hike last week. Before you go about placing the “genius” hat on members of the BOE, let me tell you that they did have an advance estimate of this report before making their rate hike decision last week. That’s OK with me! See an estimate that needs to be responded to… And do it! Way to go BOE! Good show!

Sterling, by the way, has really outperformed the euro since the rate hike last week… And I fully expect this to continue. The euro has had the upper hand on sterling for so long… I think I had a full head of hair when the euro began to outperform sterling! I like sterling to outperform the euro the remainder of this year… But, I’m not talking about by leaps and bounds! The euro remains the offset currency to the dollar!

Two of the stars from 2006, Norway and Sweden, have seen a good portion of their gains versus the dollar from 2006 erased as the price of oil weakens. But who among us really believes that with the powder keg that exists in the Middle East, and the increased demand for oil from China and India, that the price of oil will remain weaker? I certainly do not! So… If that plays out the way I expect it to… Norway and Sweden’s current pricing would look to be cheap, eh?

OK… The Bank of Japan (BOJ) meets this week, and I believe they will hike rates at this meeting. However, there are just as many non-believers on the other side of the fence regarding the BOJ and a rate hike. So, this Thursday will be interesting, eh? Oh… And we’ll have an additional reason to look forward to Thursday, as that’s the day our little Christine will have her baby!

I have to say though that I don’t think THIS next rate hike from the BOJ, whenever it does come, will be the white knight in shining armor for the yen. I just don’t think a rate hike to bring their internal rate to 0.5% is going to cause any sharp dollar/yen reversal. It’s going to take a concerted effort by the BOJ to talk rates higher, and then deliver the goods as we go along in 2007 for that sharp dollar/yen reversal to take place. But, in my mind, this is exactly what will happen… But then I’ve been so wrong on yen for so long now, that I’ve almost come full circle to being right!

So… Look for more yen weakness in the short term. Hopefully it won’t be the kind of weakness that scares investors into selling their yen positions. I’m hoping that it won’t be a crying time… But a buying time, instead.

This week’s data cupboard here in the United States is full of goodies. Tomorrow, we’ll see December’s PPI (wholesale inflation), which is expected to weaken significantly. In addition, we’ll also see the Net Foreign Security Purchases or TIC’s as they are also called. This is the report card on how well the United States is attracting foreign investment to finance its current account deficit. Recall that it takes about $75 billion per month – and recent reports have barely covered the amount.

I’ve explained many times in the past what happens when the deficit isn’t covered… But for those of you new to class, it revolves around either raising interest rates to attract additional investment, or debasing the clearing mechanism, which in this case is the dollar, thus making it cheaper for foreigners to buy our debt. Higher interest rates would hurt the economy… So, if given the choice between bringing the economy to its knees and debasing the dollar, which do you believe the government would opt for? Debasing the dollar is my answer!

Thursday brings us CPI (consumer inflation), which I believe to be a great big joke! But… The markets seem to not “get it” and put a lot of faith in CPI. So that means I have to follow it too! Inflation is expected to have increased, albeit nominally, which is the biggest bunch of baloney I’ve ever seen!

Friday, brings us the U. of Michigan consumer confidence. So, lots of goodies to deal with this week!

Currencies today: A$ .7850, kiwi .6970, C$ .8580, euro 1.2975, sterling 1.9680, Swiss .8040, ISK 70.46, rand 7.22, krone 6.40, SEK 6.9870, forint 194.80, zloty 2.9890, koruna 21.39, yen 120.30, baht 35.78, sing 1.5380, HKD 7.7999, INR 44.20, China 7.7901, pesos 10.98, dollar index 84.70, Silver $12.88, and Gold… $627.01

That’s it for today… How about that four hours of “24”? On the edge of my seat stuff, I tell you! The NFL playoff games this weekend were good, unless you’re from Philly, San Diego, Seattle, and Baltimore! My beloved Missouri Tigers gave it a gallant effort versus mighty Kansas last night, only to fall short. UGH! Got to get to trading, as the holiday yesterday has left me short a day. Have a great Tuesday and remainder of the week!

Chuck Butler, January 16, 2007

The Daily Reckoning