Beige Book Moves The Dollar Lower

Good day. Wow! What an afternoon in the currency markets. Was I ever wrong when I closed out yesterday’s Pfennig with “it should be a flat day with no data released.” While the morning was pretty boring, we saw the currencies turn in their best day in a month after the Fed released their Beige Book.

The Beige Book is a survey of regional economic performance compiled by the different Federal Reserve banks. The report, which was released just after 1:00 CST, said the pace of economic growth in the United States has slowed. Traders sold dollars as the report suggested the central bank may be closer to pausing after lifting borrowing costs 17 straight times since June 2004. Housing markets cooled, and retail sales in most areas grew at a “modest or disappointing” pace, the Fed said. Consumer price increases were “modest,” the report said.

The focus will be on the durable goods orders, weekly jobs data, and new home sales, which will be released this morning. The durable goods orders are expected to be up two percent compared to last month’s negative number. But this positive news will likely be offset by new home sales, which are expected to show a month-on-month drop of 6%.  The Fed has been keeping a keen eye on the housing market, so traders may give the housing data more weight. Friday we will get the GDP numbers for second quarter, personal consumption, and the employment cost index. The majority of this data will likely call into question further rate increases by the Fed, so look for continued dollar weakness.

A couple of reports released in Europe last night also helped the Euro shoot up into the mid 1.27 range. Germany’s consumer confidence rose to the highest level since 2001.  Germany’s economy is now on course for its best growth performance since 2000. Also, France’s joblessness fell in June for a fifth month, the longest such streak in five years.  Prime Minister Dominque de Villepin said he plans to reduce the total of jobless to below two million, a level last reached in 1983. So, the two largest economies in the euro are both recording solid economic performances and have given the ECB plenty of reasons to hike rates again at their next meeting.

One of our new ‘focus” currencies has been the Swedish Krona. This country has been turning in good growth numbers and has a central bank that is dedicated to combating inflation. Swedish consumer confidence rose in July as an improving labor market in the largest Nordic economy boosted optimism. The consumer confidence index rose to 16.4 from 15.7 in June, and a separate report showed business confidence rose to eight in the second quarter from five in the first. While these numbers probably don’t mean a hill of beans to Pfennig readers, they mean both consumer and business confidence remain at strong levels, thus indicating a healthy economic expansion. This provides the Riksbank with plenty of arguments to continue raising rates at a fairly rapid pace. With a strong economy, increasing labor market, and rising rates. The Swedish Krona should continue to be one of the star currencies of 2006.

Turning to some of our old favorites, the Aussie dollar continued to turn in an excellent performance as currency traders are now expecting two more interest rate increases in 2006. While most have expected the Reserve Bank of Australia to raise rates on August 2, 2006, recent inflation reports now have traders betting the bank will need to raise again before the end of the year.

While interest rate expectations have buoyed the Aussie dollar, they have had a negative impact on the New Zealand dollar. The kiwi was one of the only currencies to fall versus the U.S. dollar overnight as New Zealand Central Bank Governor Alan Bollard kept the benchmark interest rate unchanged. In a statement following the rate announcement, Bollard said the outlook for prices and the strength of domestic demand doesn’t justify an increase. Some traders felt Bollard would increase rates since inflation is running at 4%, above the central bank’s target range of 1% to 3%. Now, currency traders have started to place more bets that the next move by the central bank will be a cut of rates.

In a quick e-mail to me from Canada last night, Chuck reminded me that his thoughts were that the RBNZ wouldn’t lower rates any time soon. Bollard confirmed Chuck’s thoughts as he said it will be some time before he considers cutting rates because inflation is accelerating. Annual inflation won’t return to the central bank’s target range until late next year, he said.

Chuck also pointed out the good news from New Zealand, another narrowing of their trade deficit! Yes, a government report showed the trade deficit narrowed more than expected on strengthening exports. This is three consecutive months in a row. The moves are small, but at least they are moving in the right direction. While Aussie remains our top pick in this region, the New Zealand dollar is beginning make its way back.

I failed to report that India’s central bank raised its benchmark interest rate to a four year high two days ago. The central bank raised rates in order to keep inflation in check to ensure the bank’s growth forecast of as much as eight percent can be met this fiscal year.  This central bank is focusing on maintaining inflation in a very tight range, so we would expect additional tightening this year. We began offering Indian Rupee CDs earlier this year with a slightly higher minimum investment amount of $20,000. Call the desk for additional information regarding this opportunity.

China’s currency rose to the highest since the central bank scrapped the peg to the dollar a year ago as Senators Schumer and Graham told U.S. Treasury Secretary Henry Paulson today they want to see progress by Sept. 30, 2006, or else. I don’t think the policy makers in China moved the currency because of these threats, but felt the timing is right for a strengthening of the Renminbi. A stronger currency is the “best way” to shrink a record trade surplus, Zhu Baoliang, the chief economist at a research group linked to China’s top economic planning agency said yesterday. A five percent appreciation per year in the Renminbi’s value is “appropriate,” said Baoliang.

China’s banking system, which is a major factor weighing on the government’s decision on the pace of the currency’s gain, is becoming more resilient as the government introduces more hedging tools and expands the foreign-exchange market to help banks adapt to changes. Apparently these government steps have been working. China’s credit rating was raised one level yesterday by Standard & Poor’s mainly due to “efforts to strengthen the banking sector.” S&P also cited the economy’s “excellent growth prospects.”

Currencies today: A$ .7642, kiwi .6223, C$ .8836, euro 1.2741, sterling 1.8625, Swiss .8095, ISK 72.09, rand 6.99, krone 6.21, SEK 7.26, forint 213.07, zloty 3.08, koruna 22.28, yen 115.85, baht 37.80, sing 1.5775, INR 46.61, China 7.9740, pesos 10.90, dollar index 85.57, silver $11.21, and gold $633.52

That’s it for today. Hopefully we can hold on to the gains made yesterday and last night.  Chuck reports that his presentations were well received, and were actually recorded for a documentary film. We will have to see if we can get a copy of that on the Web site!  Hope everyone has a great Thursday.

Chris Gaffney
July 27, 2006

The Daily Reckoning