China Raises Interest Rates to Combat Inflation

Chris did a great job last week, keeping me up to date on what was going on… I thought he described it quite well, with the trading desks cut down to junior traders, and no one wanting to go far out on the limb with positions this close to end-of-the-year position squaring… I truly suspect that will be the case but only magnified to even slower movements and smaller volumes… But that doesn’t mean I won’t have anything to talk about!

The Eurozone periphery country debt crisis still hangs over the euro (EUR) like the Sword of Damocles, which also means that the other non-euro countries of Europe, get some of the hangover from the Eurozone… Countries like Norway, Sweden, Denmark, and even Switzerland, aren’t allowed to freely trade on their own fundamentals during times like this… But, in the end, these countries and their currencies will outperform the euro, because fundamentals eventually win out…

The precious metals of gold and silver suffered the same fate as the euro last week, with any attempts to recover, being wiped out with the next day’s trading… I think the rising yields (I’ll talk about this in a minute) in Treasuries are dealing gold and silver a speed bump that they’ve not had to deal with in the past four years…. Rising yields… But, I think they’ll get through it, when traders see that the rising yields are in reaction to rising inflation…

Chris left me a note about the commodity currencies being the destination of the money this past week, and a quick look at the currency screens tells me that the Aussie dollar (AUD) is back to parity, the Canadian dollar/loonie (CAD) is heading toward parity again, The Brazilian real (BRL) is sub-1.70 again, so… The commodity currencies are trying to shake off the “holiday slowdown” and kick some sand in the US dollar’s face!

Here’s the rest of what Chris left me…

The sovereign debt crisis has been keeping a lid on the euro, and worries about the fiscal condition of the US have been keeping investors away from the dollar. This leaves the Asian currencies, commodity currencies, and emerging markets as the only places that seem to be attractive to investors.

I failed to write much about the yen (JPY) last week, but read a couple of articles on Japan this weekend that gave me a few pieces of data to share. The Japanese government decreased their growth forecasts, predicting a 1.5% rise in GDP for 2011 compared to an expected 3.1% growth rate in 2010. The 11% rise in the Japanese yen versus the US dollar is being blamed for the expected slowdown. Japan continues to be an export driven economy, and the higher yen is definitely hurting sales of Japanese automobiles and electronics.

The BOJ (Bank of Japan) continues to use QE (quantitative easing) to try and stimulate their economy. And while Western governments have limited their buying to bonds, Japan has expanded their QE program to purchases of real-estate investment trusts and exchange-traded funds in order to bolster stock prices. With bond yields starting to creep up, we will probably see the BOJ become even more aggressive with bond purchases in order to try and force yields lower.

I still can’t figure out why the Japanese yen has attracted so many investors. The fundamentals certainly don’t support a strong currency, and growth prospects continue to be bleak. I know many investors were forced to buy the Japanese yen when they reversed their carry trades, and maybe that is what drove the yen higher. With yield differentials beginning to widen again, we could see another round of carry trades which would be bad news for the Japanese yen.

I thank Chris for not only today’s note, but for taking the conn on The Pfennig last week, while I was gone…

So… Let’s see, what else can we talk about today? Oh! China raised their interest rates 25 basis points (0.25%) last night, which we were expecting for a couple of weeks now… I like the fact that the Chinese didn’t knee-jerk a rate hike two weeks ago, and I think the currency traders, at least the ones that are still around this week, like that too… Like I said above, the Aussie dollar is back to parity with the US dollar, and that wouldn’t have happened if China had knee-jerked a rate hike two weeks ago…

The Chinese believe that they are ahead of their rising inflation… I say… “Hey, if they say so”!

The 10-year US Treasury continued to rise last week and is now at 3.45%… Remember that on just November 10th, this bond’s yield was 2.63%… (Remember that when a bond’s yield rises, the bond’s price falls and vice versa when the bond’s yield falls)… This move is a full 6-point fall in the price of the bond… If you owned $100,000 par of this bond, your loss right now would be $6,752! … Remember, a couple of weeks ago, when I said that I wasn’t sure if this was actually beginning of the end of the Treasury bubble, because we had seen a couple of head-fakes before? Well… I’m becoming more convinced that this is the real deal with every passing day… Even the threat of the Cartel/ Bernank coming in and buying bonds in their effort to keep rates low, isn’t holding the selling back… This could get quite ugly, folks… Quite ugly…

And while the US Treasuries take it to the chin and mid-section, the price of oil is back above $90 (at $91) and looking as if traders might be targeting $100 oil once again…

You know… Food and energy is taken out of the CPI, and people like me put them back in when reporting CPI, because whether the government takes it out and tries to show you that inflation doesn’t exist… But, you and I know that it’s not just food and energy that’s hitting our wealth with inflation right now… I’ve given you all kinds of examples in recent months… But here’s one that hit me the other day… Now, I have a monthly prescription that I’ve gotten for years…and with the same insurance! Well, three years ago, it was $20 per month, last year it went to $40 per month, and last week when I picked it up it was $60! Now, same prescription, same insurance paying a piece of the bill, and the rise in the price was tremendous!

OK… Enough of that! Inflation scares the bejeebers out of me, and I know it’s all around me right now…

But not according to Big Ben Bernanke! He’s still chasing the deflation ghost… I used to have a guy send me emails almost daily, beating me up for just about anything I said, but especially about inflation, as he read the Big Ben Bernanke book on dealing with deflation, and truly believed that deflation was the “thing that would kill us all!” I haven’t heard from the guy in quite some time now… Yes, house prices are still deflationary… But that’s just one asset.

Speaking of rising inflation… I told you a couple of weeks ago that Brazil’s inflation was rising and the central bank was dragging its feet with reaction to that rising inflation… Well, Brazilian economists, now join me in pointing to rising inflation in Brazil, which is going to hit 5.9% for 2010, even with a boat-load of rate hikes earlier this year… So, with no further follow up on the rate hikes, I don’t see how Brazil is going to deal with inflation in 2011… Come on, Brazilian Central Bank… Get off your duffs!

Well… I guess the data cupboard this week will gives us a couple of reports, but there’s really not a whole lot in there. Tomorrow, the S&P/CaseShiller Home Price Index for October will print, along with consumer confidence…

The “experts” believe that consumer confidence is going to rise this month… I would say that’s probably true, but my belief is based on a different kind of consumer confidence… I believe that consumers are “consumed with unemployment” and “consumed with debt” and… I could go on, but you get the point… These consumer confidence surveys must be given to the same Pollyanna, everything-is-seashells-and-balloons people every month!

Then there was this… I will be on the radio this Sunday on: on WAAM Talk 1600 a weekly radio show, with Doctor Dave Janda, airing Sunday from 3-5 PM… Doctor Dave Janda has really taken to hosting this radio show each week, and has attracted quite a few “name” guests… I’m just filler… but that’s fine with me. I always enjoy talking to Doctor Dave, for he truly understands what the government is doing to our kids’ (and grandkids’) futures… So… If you’re not living in the Ann Arbor area, you can get the streaming broadcast here… And I bet you can guess what I’ll be talking about!

To recap… The currencies and precious metals are pretty much stuck in a range with only the commodity currencies gaining in traction versus the dollar, in holiday/year-end slow market trading. US Treasury yields are really rising along with the price of oil… (Does anyone think inflation is coming? I do, I do!) And China raised their interest rates by 25 basis points last night, believing they are ahead of their inflation…

Chuck Butler

for The Daily Reckoning

The Daily Reckoning