Between a Rock and a Hard Place

Good day… Well, a quick look at the news articles on Google this morning regarding subprime mortgages yields 551 stories, and counting! This meltdown in the subprime mortgage sector is beginning to spread its tentacles into other markets. For instance, the Dow was down on fears that this meltdown will be disastrous. The corporate bond market is beginning to feel the heat too. And guess what? I think it’s already playing out in the U.S. economy.

Retail sales for February were awful! Proving once again that the BHI is a good indicator, retail sales showed a meager 0.1% gain in February, disappointing forecasts for a 0.3% increase. So there was the small tick up like the BHI said there would be, but in the end… There’s nothing here to write home about! So far this year… January’s retail sales printed at 0% growth, and February’s at 0.1%. Oooh, the strength just sends chills down my spine!

Is this enough to get the Fed to cut interest rates? No… Not yet. The rock and the proverbial hard place is where you will find the Fed Heads these days. But don’t feel sorry for them… They are the ones that looked the other way when inflation was soaring and left rates at 1%!

I’m not even going to get on my soapbox this morning about the Fed, Big Al, and the rest of the lot, including the new Chairman Big Ben. I’ll leave that for another day, not like I haven’t already taken them to the woodshed a time or two hundred in the past!

The dollar got sold after that disappointing retail sales figure printed. But it really got some wind in its sales when it was reported that total home loan delinquencies rose to 4.95% from the 4.67% reported for the third quarter of ’06.

The deterioration was broad-based, with late payments rising for all types of loans. Delinquency rates rose in 49 states, and foreclosure rates rose in 44 states. With no surprise to yours truly, FHA and subprime loans deteriorated the most, with FHA delinquencies rising to a record 13.46% and subprime ARM delinquencies rising to 14.44%.

You see, this meltdown is causing market volatility, and you will recall (hopefully) what happened in the currency markets two weeks ago when volatility got all lathered up. That’s right…the carry trades got unwound. Japanese yen gained five whole yen in a week, and the high yielders like New Zealand for instance, saw selling.

We’ve seen more of this type of activity overnight, with yen back to within spittin’ distance of the 115 handle again, and kiwi losing ground. Pound sterling has seen some selling, too, so it certainly looks as though it is another Wayne’s World mention – Game On! Oh, and don’t look now but Swiss francs, another currency that was used as a funding currency like yen, has popped up over 82-cents!

Yesterday, I told you about the strong German investor confidence report. And today, another think tank, ZEW, posted a strong business sentiment report. ZEW says that their business sentiment index rose to 5.8 in March versus the 2.9 showing in February… Good Show!

Again, this alls plays well, with my thoughts yesterday that Germany has weathered the VAT storm, and that the Eurozone economic recovery ship should have enough fuel to remain at sea much longer! And… Give the European Central Bank enough moxie to keep raising rates!

The euro did go above the 1.32 handle yesterday for much of the morning, only to fall back at the end of the day. However, once the negativity returns in force for the dollar, I expect 1.32 to be a small figure in the euro’s rear view mirror, as it speeds toward 1.40. Of course, that’s just my thoughts/opinions… I don’t know more than anyone else about the direction of the euro/dollar, just telling you what it looks like to me!

Today’s U.S. economic data cupboard yields only the current account deficit report for the fourth quarter. It is expected to have “narrowed” from the previous quarter’s unsustainable $225 billion, to remain above $200 billion… I’m glad to see the current account deficit narrowing, but this isn’t even close to what it needs to be in a given quarter, much less annualized. So, let’s not get too lathered up about this.

Tomorrow, we’ll see the TIC data for January. Recall that December’s total net inflows to the United States amounted to only $15.6 billion? Well… Right now the experts have forecast these inflows to amount to only $65 billion in January. Again, let me remind you that the monthly requirements for foreign financing are north of $75 billion! Uh-Oh! The deficit isn’t getting financed. Either rates are going to go sky high to attract financing… Or the dollar is going to get a lot weaker to allow purchases to finance to be done at a cheaper price!

And since the Fed CANNOT, let me repeat, CANNOT afford to raise rates right now with the subprime mortgage meltdown going on… Guess what gets discounted? The dollar! Well… We’ll have to see the color of tomorrow’s printing of the report, but I’m sure this is the direction in which we’re going, so I sure hope you are prepared for this.

Gold and silver saw some selling yesterday. I’m not quite sure why, except the risk aversion thing that comes from the volatility I talked about earlier. Think about gold like this… The Fed isn’t going to be raising rates any time in the near or distant future. Instead, they will most likely have to lower rates later this year, in hopes of coming to the aid of the housing market. On a side bar… Of course this will be too much, too little, too late, as usual for the Fed.

Anyway… If interest rates are going to eventually go down… That will make the dollar even less attractive… And should make gold much more attractive, don’t you think? I do!

Currencies today: A$ .7830, kiwi .6875, C$ .8425, euro 1.3195, sterling 1.9250, Swiss .8225, ISK 67.75, rand 7.4950, krone 6.15, SEK 7.05, forint 190.80, zloty 2.9570, koruna 21.3470, yen 116.10, baht 33.10, sing 1.5355, HKD 7.8140, INR 44.27, China 7.7380, pesos 11.20, dollar index 83.77, Silver $12.69, and Gold… $640.10

That’s it for today… Well.. Have you filled out your NCAA basketball brackets yet? Games start tomorrow! Don’t forget about St. Patrick’s Day on Saturday either! A wearin’ o’ the green is in store! I’ve gotten pretty old to be out painting the town green, so I leave that to the youngsters, and remain in the “hood” with other friends that have allowed discretion to be the better part of valor when it comes to painting the town green! Have a great Wednesday!

Chuck Butler — March 15, 2007

The Daily Reckoning