Blue Light Specials Are Over

Good day… We had a fairly light day in the markets yesterday, as most traders were enjoying the day off to remember our Veteran’s. But the damage in the Asian markets continued overnight and the re-introduction of risk aversion caused some pretty good losses in overseas equity markets. This risk aversion is what caused this weekend’s strong move by the yen (JPY) and selloff by the higher yielding currencies of New Zealand (NZD), South Africa (ZAR), Great Britain (GBP), and Australia (AUD). But the buying opportunity for Aussie dollar didn’t last long, as the dollar began to slide again in European trading and moved both the Aussie and New Zealand dollars up over 2% in the last 24 hours.

As Chuck pointed out yesterday, we will have a number of reports released this week which will likely showcase the weakness of the U.S. economy. Today we will see the monthly budget statement, which is expected to show a shortfall of $59 billion in October. This cheery number will then be followed by the pending home sales number expected to come in at an improved -2.5% compared to last months dismal -6.5% showing. And bringing up the rear today will be the ABC consumer confidence number, which is expected to have weakened slightly to -16.

It almost seems like the markets are trying to set us up for a surprise. The expectations for these numbers are so bad, the risk is probably that at least one of the pieces of data comes in above expectations and the markets can point to it and say, “See, we told you things are really as bad as everyone is making them out to be.”

Chuck spent the day in meetings down in Florida yesterday, but had some time in the morning to read The Wall Street Journal and sent me the following last night:

“Did you all see the two currency articles in The Wall Street Journal yesterday? One was titled, ‘Dollar’s Diagnosis Depends on the Doctor’… And the other was titled ‘Loonies Sharp Rise Gives Canada a Splitting Headache’…

“The first story dealt with the fact that the dollar has continued to drop even though Treasury Secretary Paulson keeps talking about a strong dollar policy. ‘Talk is cheap’ was one of the quotes, as they spelled out one of the facts that I totally agree with and that is… There’s little the Treasury or Fed can do to bail out the dollar. Nor would the administration want them to, unless the fall got completely out of hand, and the Asian Central Bank along with the petrol producing countries began to bail out of dollar holdings…

“The second story told of how Canadians celebrated when the loonie (CAD) hit parity to the dollar, but have since become somewhat concerned about how far and fast the loonie has gone…

“But, the writer could have saved some ink had he just waited a day or two, to see the loonies sell off… Aussie, New Zealand and Canada have all ceded gained ground versus the dollar in the past couple of days… But… In my eyes… This is merely a correction and nothing more… Especially for Aussie and loonies. They have far too much going for them without the high yield of kiwi.

“I told the group of EverBankers gathered here on Amelia Island that I believe we are really stuck in risk aversion again, and that will drive Treasury yields lower, along with the high yielding currencies. I actually saw Japanese yen trade in the 109 handle yesterday… And the other funding currency of the carry trade, Swiss francs (CHF)? Well… Let me be the first person on your block to tell you that IF the carry trade is truly unwinding… Swiss francs could be heading to parity with the dollar! I say this because of all the trades shorting this currency.

“I also told the group that last year, I told the ALCO committee in January that euros (EUR) would hit 1.40, sterling 2.10 and yen 110 in 2007… I was sweating bullets with yen… But 110 finally came around, and therefore all three levels were hit! You see… I can say things like that in a corporate setting with no customers around… Unfortunately, the regulators watch me like a hawk, and are waiting to pounce on me if I said things like ‘the euro will go to…’ So… I made my forecasts for those three to the group here… Let’s hope that next year at this time I can receive another straight ‘A’ report card!”

Chuck has done a great job of calling the trends over the past few years, and I would encourage all of the readers to try and attend one of the many presentations that he is scheduled to make this year. He is as enjoyable a speaker as he is a writer.

The Bank of Japan did exactly what the market had predicted and kept their interest rates unchanged at the lowest levels among the industrial nations. As we have reported in past Pfennigs, the Bank of Japan seems to be frozen by a fear of what higher rates will mean to their economy. By not moving more quickly to raise rates, policy makers are actually adding to the imbalances that they fear. Governor Fukui said that Japan’s “very low rates” still need to rise to a level in line with the economy’s expansion and to deter companies from making risky investments with cheap credit.

Chuck sent me his thoughts on the latest move by the Japanese yen:

“Speaking of Japanese yen… How about their latest economic growth report? Japan’s economy grew faster than economists forecast in the third quarter, as an unexpected increase in consumer spending led the way. The world’s second-largest economy expanded an annualized 2.6% in the three months ended September 30 from a revised 1.6% contraction in the previous period. Let me tell you this now, and hope you don’t wait to pay attention to me later… If the carry trade is truly unwinding, and economic growth in Japan is rising… Those short positions had better get closed out in a hurry!”

The yen just couldn’t stay below 110 after the rate announcement, as the BOJ almost seems to be encouraging carry trades again. Expectations of low rates will top out the yen’s advance until the BOJ begins to take a more hawkish stance.

U.S. Treasury Secretary Henry Paulson is heading over to Africa to meet counterparts representing the world’s biggest economies. But according to what his counterparts have been saying, Hank shouldn’t be looking for a warm greeting. European finance ministers have been working overtime complaining about the weakness of both the U.S. dollar and the Chinese renminbi (CNY). Paulson, like his four predecessors, has stuck with former Treasury chief Robert E. Rubin’s phrase that a “strong” dollar is in the U.S.’s best interests. Officials have repeated the phrase regardless of whether the dollar was rising or falling. But talk is cheap, and officials have done nothing to try and stem the fall of the U.S. dollar. In fact, they have been piling on with the rest of the world complaining about the weak renminbi.

But, you may ask yourself, what can we really do about the falling dollar. For one, we could tighten the purse strings a little. This administration has run up more deficits than the last two combined. As announced by Paulson’s U.S. Treasury department, U.S. debt topped $9 trillion (yes that is a T not a B) for the first time ever. And there doesn’t seem to be any urgency by our congress to reduce these debts as Congress raised the statutory borrowing limit again about a month ago. Deficit spending and promised benefits for federal entitlement programs have put every man, woman, and child in the United States on the hook for $175,000, says a new report by David Walker, comptroller general of the United States.

And can we really complain about all of the deficit spending by the U.S. Congress when we don’t seem to be able to curb our own personal consumption? Credit card debt owed by Americans in now a record $915 billion. This is debt owed on credit cards, backed by nothing but disposable assets.

Another factor weighing on the dollar is the continuing diversification of central bank assets. A United Arab Emirates central bank official yesterday said the country’s dollar peg was at a crossroads. I guess all of these oil-producing countries are starting to question the idea of accepting the plummeting U.S. dollar for their black gold. The Central Bank Governor of UAE fueled speculation that the country may end its fixed-exchange rate against the U.S. currency. Governor Sultan Bin Nasser al-Suwaidi said, “We have reached a crossroads now with a further deterioration in the U.S. dollar and expected further weakening of the U.S. economy.”

The UAE has no plans to drop the peg alone, and any decision will be made by the Gulf Cooperation Council “at the right time,” he said. Kuwait has already dropped the dollar peg, and other Middle Eastern central banks will likely follow. All of this talk will not have a positive impact on the dollar, as investors will follow central banks and diversify out of their dollar holdings. Hopefully our Pfennig readers are a step ahead of all of these other investors and have already begun their diversification strategy!

Currencies today: A$ .8962, kiwi .7602, C$ 1.0470, euro 1.4607, sterling 2.0711, Swiss .8885, ISK 60.38, rand 6.7660, krone 5.4116, SEK 6.3582, forint 174.04, zloty 2.49, koruna 18.27, yen 110.19, baht 31.60, sing 1.4488, HKD 7.7840, INR 39.44, China 7.4324, pesos 10.914, BRL 1.7715, dollar index 75.812, Oil $93.98, Silver $14.67, and Gold… $803.67

That’s it for today… We worked a full day yesterday in spite of what was supposed to be a “bank holiday”. We have been a little short staffed lately, and the business of diversifying investors out of the dollar is booming. But we seem to be caught up again, and looking forward to another big push out of the dollar. Hope everyone has a Terrific Tuesday!!

Chris Gaffney
November 13, 2007

The Daily Reckoning