Bernanke's Hands Remained Tied

Good day… The dollar gained strength going into the FOMC announcement yesterday and held afterwards. As Asia started trading, the dollar gained even more, with the euro (EUR) touching 1.3720 before moving back up to 1.3770 as I write. As expected, the big story of yesterday was the FOMC decision. The markets were waiting to see if Bernanke would ease off his inflationary watch and start showing some concern over the subprime meltdown. Well those that were expecting him to turn dovish were disappointed, but so were some of us who think he should be doing more about inflation. Chuck is on the side of the hawks, and had this to say about the FOMC’s statement:

“Talk about not having intestinal fortitude (guts)… Well… Most people know that the Fed left rates unchanged yesterday, as I thought they would. But, here’s where I’m calling out the Fed Heads for their lack of intestinal fortitude… These guys still keep talking about inflation… But they don’t do a darn thing about it!

“This is from their statement following the ‘no rate hike/cut decision’. The Fed reiterated that its primary concern was that ‘inflation will fail to moderate as expected.’

“Oh really? If inflation is failing to moderate, then why don’t they do something about it? Bawk, Bawk, Bawk… Did I hear a chicken? No, I heard a whole hen house of chickens!

“But what are they to do? Their hands are tied! They can’t raise rates to combat inflation due to the mortgage meltdown and the threat of a huge hickey to the economy… And they can’t cut them due to the inflation failing to moderate! Oh, poor, poor, Ben Bernanke… His predecessor left him this bag of wooden nickels for an economy, and he has to deal with it!

“Of course, you know me… I’ve harped on the Fed for years now. They cut rates too low… They left them there too long… And when inflation began to get out of hand, they drug their feet raising rates Tutor Turtle style! And, then what happened? The mortgage bubble.

“OK, I’m tired of talking about the Fed Heads… I’m sure they are smarter than me, and will get this all figured out, eh? And… The markets took the bait, hook, line and sinker! They are truly under the impression that the Fed can raise rates, and when they talked about inflation… The dollar got bought. One of these days, Alice! Yes, One of these days, these guys buying dollars will get their heads handed to them.

“As expected, The Reserve Bank of Australia, (RBA) did raise rates to an overnight cash rate of 6.5%. This rate hike will be used to prove the RBA to be independent of the Government, as Prime Minister Howard, is seeking a fifth term. He had asked that rates remain unchanged… But to no avail, eh?

“I got a huge kick out of Addison Wiggin & Ian Mathias’s 5 Minute Forecast yesterday… One guy that I absolutely despise is Jim Cramer. This guy, oh never mind, let’s just say I don’t like him. So, I’m reading the 5 Minute Forecast yesterday, and here’s what they had to say about Mr. Cramer…

“‘On July 16, James Cramer dismissed the unfolding subprime mortgage crisis as “meaningless.” Then just a few weeks later, he’s literally screaming that there’s “Armageddon” in the income markets.

“‘Cramer, pounding his fist, wants Bernanke to ‘stop acting like an academic and do something!’ He wants the Fed to cut rates and bail out the traders and fund managers who were buying up these subprime loans as if they were income instruments. What he wants, essentially, is a return to the Greenspan days.”

“This about face by this guy is classic, eh?”

I love watching Chuck react to the TV when Cramer is on. He not only disagrees with the guy; he truly doesn’t like him.

None of the data scheduled to be released today will bail out the dollar from the selling, which started when Europe opened. MBA Mortgage Applications increased 8.1% this week, but nobody is thinking this number shows the housing market is turning; it only proves more people are trying to get loans (ARM resets?). Wholesale inventories will be released later this morning, and are expected to have increased 0.4% in June compared to May’s 0.5% increase. Again, this number will be a non-event.

Looking at the rest of the week, I don’t see anything that should help the dollar. We will get the weekly jobs data tomorrow, followed by the Import Price Index and Monthly Budget Statement on Friday. Next week will bring us some data that could move the dollar, but the rest of the week should be pretty un-eventful as far as the numbers go.

The pound sterling (GBP) got some love from the Bank of England this morning as their forecasts suggest one more interest rate increase will be needed to bring inflation back to target. The BOE forecast, released today, assumes the bank will raise its benchmark rate a quarter point to 6% by the first quarter of next year. Inflation has exceeded the U.K. central bank’s target for 14 months because of gains in food and energy costs. Policy makers have lifted borrowing costs five times in the past year to the highest in six years. These expectations of higher rates have moved the pound back above $2.03 this morning, and should continue to keep it supported.

In past Pfennigs, I have written about the argument between France’s two pre-eminent statesmen, President Nicolas Sarkozy and the ECB President Jean-Claude Trichet. Sarkozy, in typical French style, has continually whined about the interest rate increases, which the ECB has made to combat inflation. ECB President Trichet, acting more like a hawkish German central banker, has all but ignored Sarkozy’s bellyaching and kept a strong vigilance against inflation.

Well today it was reported that French exports rose the most in two years in June, cutting the nation’s trade gap and undermining Sarkozy’s complaints that the euro’s advance makes European goods less competitive abroad. Exports increased 6.2% from the prior month, the biggest jump since April of 2005. ECB President Trichet has already signaled that the central bank will raise rates again next month, so we will have to see if this latest data will stop Sarkozy’s whining. No matter what, the euro will continue to benefit from the rate increases and should challenge $1.40 again in the next few weeks.

Swiss unemployment declined in July, keeping the jobless rate at the lowest in almost five years, as economic growth prompted companies to step up hiring. The jobless rate held at 2.7%, the same as in June. Switzerland’s leading economic indicators rose to the highest level in 10 months in July, as the economy shows few signs of cooling from the fastest economic expansion since 2000. Switzerland’s central bank has signaled it’s ready to raise interest rates in September to keep economic growth and hiring from fueling inflation.

With all of this good news, you would expect the Swiss franc (CHF) to be moving up; and it has for the past month, appreciating faster than any other European currency. But over the past three days the Swiss franc fell as investors moved back into the carry trade. Yes, the Swiss franc is again being sold by those who are borrowing at their low rates and investing the funds into higher yielding assets. Look at this dip as a perfect opportunity to move into a currency that has a lot going for it. The carry trade will not last; we have already seen what can happen when the market starts moving out of it. The Swiss franc is a good currency to own as a hedge against volatile markets.

Chuck spoke briefly about the increase by Australia’s central bank, so I will just let you know that this increase did help the Aussie dollar (AUD) back above 0.86 this morning. The currency had fallen dramatically from its highs of 0.8871 on July 25, but looks to be back on the rally track. The Aussie dollar remains one of our favorite currencies, combining relatively high interest rates with a currency that is trending up. Australian exports of commodities should help them continue to grow, in spite of these higher rates.

China is Australia’s largest destination for many of these commodities, and the Chinese economy continues to grow at a tremendous pace. China’s central bank said consumer price gains may accelerate on food and labor costs, fueling speculation that it’s five days away from announcing the highest inflation in 10 years. July’s inflation figure for the world’s fastest-growing major economy is due August 13. How can China combat these rising prices? By raising interest rates and letting the renminbi (CNY) move up in value.

This is exactly what currency traders are predicting will happen. According to the implied forward rate on the non-deliverable currency contracts, the renminbi will advance 6.2% over the next 12 months. The People’s Bank of China said today that preventing overheating in the economy is a top priority. The market will play a greater role in the renminbi’s reform, the central bank said. Look for accelerated appreciation of the renminbi from now until the opening of the Olympic games, which are only a year away.

Currencies today: A$ .8580, kiwi .7636, C$ .9501, euro 1.3772, sterling 2.0310, Swiss .8362, ISK 63.39, rand 7.0338, krone 5.7940, SEK 6.7075, forint 180.82, zloty 2.7419, koruna 20.462, yen 119.39, sing 1.5125, HKD 7.8286, INR 40.5275, China 7.5748, pesos 10.9225, dollar index 80.45, Silver $13.09, and Gold… $673.10

That’s it for today… It is extremely hot and muggy here this morning, with overnight temps only making it down to the high 80’s and humidity hovering around 75%. It is supposed to get over 100 again today and they say we won’t get a break from this weather pattern until the end of the month. You got to love St. Louis summers!! Hope everyone has a great hump day, Happy Wednesday!!

Chris Gaffney
August 8, 2007

The Daily Reckoning