Another Rock/Hard-Place Situation

Good day… And good morning from sunny Colorado. While Chuck has been looking forward to a little sunshine and warmth, we have been hoping for a little colder weather and some snow up here in the mountains. Upper 50s and sunny doesn’t make for the best skiing as we have had to keep a sharp eye out for rocks in the middle of the ski runs. The Federal Open Market Committee has also been trying to negotiate some pretty rocky terrain and now finds itself stuck between the proverbial rock and a hard place.

In the statement released at the conclusion of its two-day meeting, the FOMC acknowledged recent data that shows both higher inflation and a weaker economy. This is pretty much a worst-case scenario for Bernanke and his boys (and girls). The economy is showing signs of slowing down but inflation continues to be a threat.

The committee dropped a phrase from previous statements about the “additional firming that may be needed,” a change interpreted by the markets that the Fed continues to move closer to cutting interest rates later this year. But with forces pushing the FOMC in opposite ways – to raise rates to quell inflation and to lower rates to revive growth – the FOMC has opted to do nothing for now.

This lack of a clear direction has helped increase volatility in the financial markets. The stock markets have seized on the possibility of another rate cut to rally share prices, while the bond market continues to worry about the possibility of rising inflation. For how the currency markets reacted to the news, I went to the best currency trader I know, Chuck Butler (and yes he is also my boss).

Chuck had this to say before heading out the door to spring training:

“The currencies didn’t react to this news at first, which surprised me, because the final dollar prop has been removed. However, after reviewing the statement, traders began to mark down the dollar. The euro, as a benefit to being the offset currency to the dollar, saw most of the early upward movement, but soon enough, yen, sterling, kiwi and Aussie all had reached intra-day highs a half a cent above where they began the day.

“Back to the Fed, before I go on… I told you that the Fed was in a pickle… And I think they are ‘getting the picture’ as they downgraded their previous euphoria over growth. Moving their recent growth indicators from ‘firm’ to ‘mixed’. However, they are still living in fairy tale land with their outlook for the housing sector, saying ‘housing showed tentative signs of stabilization to its adjustment continuing on.’

“Geez Louise, just when you thought they had crawled out from under that rock! ‘Tentative Sign of Stabilizing?’ What a crock!”

Today Chairman Bernanke will speak in Washington and the markets will wait to see the tone of his comments. A dovish tone by the Fed Chairman would send the stock markets up higher and dollar down, but if he cautions about inflationary pressures, we could see some dollar strength. We will also get the weekly jobs data, which will likely show that jobless claims rose last week, further confirming a weakening U.S. economy.

The euro got some support overnight after ECB president Trichet said policy “continues to be on the accommodative side,” and inflation is “subject to upside risks.” This hawkish talk pushed the euro up to $1.3411 (the highest since March 2005) before profit taking took it back down below $1.3360. In spite of this slight pull back, the euro remains in an uptrend, as the ECB is likely to continue its bias toward higher rates.

Our Corporate FX guru, Ashish, circulated a research paper from Goldman Sachs that contained their technical charts on the euro. Basically, their technical charts showed that if the euro closed over the 1.3365 level, the next target would be 1.37. While the euro wasn’t able to hold above 1.3365 overnight, it is very close. So according to the expert chartists at Goldman Sachs 1.37 is definitely a near term possibility. It is great when both the economic fundamentals and the technical charts point in the same direction.

According to Citigroup Inc., both the fundamentals and technicals are also pointing to a rise in the pound sterling. In a note to clients yesterday, Citi said the pound will rise to a five-week high against the euro as accelerating wages will lead the Bank of England to raise interest rates as soon as their next meeting April 4-5. “The technical analysis of price charts shows the pound is poised to gain”, the report said.

The pound rose to the highest in six weeks versus the U.S. dollar after a report showed sales at U.K. retailers rebound more than expected last month, adding to speculation that the BOE will keep raising rates.

Chuck was almost able to get through an entire Pfennig yesterday without talking about the subprime meltdown, but he just couldn’t help sending me these thoughts on the latest talk about a government bailout:

“Let me switch gears to this two-week old baloney going around in Congress, where lawmakers, and I’m not going to mention names, are going to review the mortgage business, to have taxpayers bail out these borrowers that can not make their house payments. Can you imagine just how screwed up this whole mortgage process will be if Congress gets their hands in there – acting like they know what they’re doing? YIKES!

“One of my fave economists/writers for Bloomberg, Caroline Baum, wrote what I was thinking… ‘While lawmakers’ intentions may be noble, it’s a pretty safe bet that, left to their own devices, they will muck things up even more.'”

I think that having taxpayers bail these borrowers out is WRONG! And we certainly know where Chuck stands on this issue!

And to end today’s Pfennig, the commodity currencies of Aussie dollar, New Zealand dollar, Canadian dollar and the South African rand all rallied yesterday, as talk of higher inflation rallied gold. The combination of increasing commodity prices and high interest rate differentials to the United States has pulled these currencies back up. But the risk of carry trade reversals still hover over the rand and the New Zealand dollar, so use caution when investing in these. As you know, the Aussie dollar continues to be one of our pick currencies.

Currencies today: A$.8080, kiwi ., C$ .8642, euro 1.3361, sterling 1.9715, Swiss .8260, ISK 66.27, rand 7.2268, krone 6.1060, SEK 6.9618, forint 184.09, zloty 2.8964, koruna 20.945, yen 117.545, baht 34.645, sing 1.5174, HKD 7.8089, INR 43.64, China 7.7260, pesos 11.012, Silver $13.33, and Gold $658.75

That’s it for today… The big boss, Frank Trotter, just happens to be out here in Colorado this week also. He sent me an email of a chance encounter he had yesterday which I just had to share. Here it is: “Wanted to give a shout out to my new favorite Snowmass Ski Patroller – not only does he clean up after klutzes like me but he’s an EverBanker! Unable to concede a full day of inactivity after meetings conspired to take skiing off the agenda, I strapped on some snow spikes to hike from Snowmass Village to the top of Sam’s Knob (2,000 ft up). After I dragged myself across the finish line I bumped into my new friend – after a few snow pleasantries he noticed my EverBank hat and you know where the conversation went. For those of us who prefer the mountains to the beach, here’s a thank you for all the hard work and patience ski patrols all over snow country provide!” I will definitely second that! And now I am heading out the door to hit the slopes with my family. Have a great day!!

Chuck Butler — March 22, 2008

The Daily Reckoning