Bernanke Stays The Course

Good day. And a Happy Friday to one and all! Well, the Fed did come through with a rate hike of 25 BPS as I suspected and hoped (read all of this week’s Pfennigs!). However, as I said yesterday, there seemed to be a grassroots effort to talk up the possibility of a 50-BPS hike. When that didn’t happen, the dollar got sold!

There’s also the question of Big Ben’s press conference and statement following the rate announcement. Once again, Big Ben has confused the markets. They seem to think he was “dovish.” Personally, I think he was just as vague as his predecessor!

He noted, “Some further tightening may yet be needed.” He went on to say, “The committee sees growth as likely to moderate to a more sustainable pace,” and, “inflation expectations remain well contained.”

I don’t find any dovish vibe in those statements, except for the fact that he acknowledges that the Fed does realize that the economy is slowing. So, we’re still going to battle these rate hikes the rest of the summer. I truly expected this to be over by now, and the currencies sailing into a sea of calm. I think the currencies will still be sailing this summer to the island of seashells and balloons, but the water will be choppy at times!

I’m sure many long-time readers are thinking, “Hey wait a minute, Chris was supposed to write the Pfennig today. He sure is starting to write like Chuck!” Well the fact is Chuck left me these opening paragraphs sometime last night. I think he heard me complaining what a tough time I have getting it going in the morning and wanted to see if he could help me. Or, maybe he just feels a little sorry for us junior guys who have to man the desks on holiday weekends. Whatever the reason, I sure appreciate his help.

As Chuck wrote, the currency markets took the quarter-point raise and accompanying statement as signals the FOMC is near the end of the rate hikes. The U.S. dollar fell by the most in two months against the yen and was down nearly two cents versus the Euro.  The currency moves were fairly widespread with all of our favorites showing good gains.  Even the commodity markets rallied on the news, with silver up and gold trading above $600 again (Goes to show you just how crazy these markets are:  The currency and equity markets rally because the FOMC is dovish and gold, the true inflation hedge, rallies also).

The data out today may show a slowing U.S. economy, which would give even more support to the dollar bears. Personal spending and income for May is expected to show some of the slowest gains this year. Economists are predicting a 0.4% rise in spending and just a 0.2% rise in income. It looks like the U.S. consumer may be slowing down a little, but we still seem to increase our spending more than our income! The Chicago purchasing manager report will also be released this morning and is expected to show a slow down in the Chicago area business activity. A slowing U.S. economy is in stark contrast to the data coming out of Europe and Japan, which reflect continued growth.

Government reports released this morning showed German unemployment fell for a third month in June, adding to signs the region can cope with higher rates. This report, along with the confidence numbers we spoke about earlier this week, shows the European economy is robust and makes a case for the ECB to get even more aggressive with their interest rate hikes.

Another report released last night showed Japan’s consumer prices rose at the fastest pace in eight years, signaling deflation in the world’s second-largest economy is almost beaten and supporting the Bank of Japan’s case for raising rates from near zero. Japan’s unemployment rate fell to an eight-year low of four percent according to another report.  As in Germany, the labor market has gradually tightened and consumer spending is strengthening, suggesting inflation pressures will mount. Japan’s Tankan business confidence survey will be released Monday, and is expected to show Japan’s biggest companies will increase spending by nine percent this year, three times the rate they forecast in March. All of this data certainly supports our expectations for interest rate increases in Japan and a yen that should finally break back out of the range trading we have seen and pass through 110 level on its way toward a very good appreciation for 2006.

A very nice rally took place in the Canadian dollar/loonie yesterday, and it began long before the Fed press conference! Yesterday morning, Canada printed a stronger GDP, a stronger industrial production, and a stronger increase in wages. As Chuck would say, this economy is “smokin’!” While many will expect Canada to keep pace with the United States interest-rate increases, the recent data shows the Canadian economy may cause them to continue even after the United States is finished. A strong economy and stable commodity prices should keep the loonie firm in the long run!

Now on to the big finish.

Currencies today: A$ .7423, kiwi .6087, C$ .8994, euro 1.2712, sterling 1.8342, Swiss .8112, ISK 76.59, rand 7.16, krone 6.2374, forint 222.21, zloty 3.18, koruna 22.40, yen 114.66, baht 38.18, sing 1.5856, INR 46.03, China 7.9943, pesos 11.299, dollar index 85.61, silver $10.71, and gold $600.05 (Back above $600!)

That’s it for today. Good luck to Chuck’s beautiful bride who is getting her eyes worked on today (the real reason Chuck took off, not just to make the weekend longer!). I hope everyone has a great Fourth of July weekend. Trading should be light both today and Monday, but light trading sometimes means volatile markets. Anyway, hope you all get to spend some time with your families this weekend. Have a great Friday!

Chris Gaffney
June 30, 2006

The Daily Reckoning