Commodity Currencies Retreat on News from China

Well… It’s been a long cold, snowy week, and at the back end of it, we’ve seen quite a currency rally… Quite strong indeed! So, let’s take a look at what’s fueling it, and if it will hit another speed bump this time. Ready, set… Let’s go!

Well, the euro (EUR) has been buoyed the past two days by good periphery country bond auctions… Then yesterday, following the European Central Bank’s (ECB) meeting, ECB President, Trichet made some hawkish comments about inflation rising, which, by mandate, would require the ECB to raise interest rates… And Trichet let everyone know that he’s prepared to raise interest rates if needed. We watched the euro gain over 2-cents yesterday, and was heading to 1.34 when I left the office for home.

Overnight, the euro traded to a recent high of 1.3445, but then the Chinese put down a speed bump… And the euro fell back to 1.3350, in a NY Minute. The commodity currencies, of Aussie (which traded very close to parity again, yesterday), Canada, New Zealand, Norway, and the list goes on, have traded back even more on the Chinese news… So… If the currencies all got the rug pulled out from under them overnight by China, I guess I had better head to China to get the skinny, eh?

China hit the markets with another reserve requirement hike last night. China raised their largest banks’ reserve requirements 50 Basis Points (1/2%) to 19%… China is doing everything they can to squash their rising inflation problem. So much so, that I have to believe that China will go so far as to raise interest rates at least 50 Basis Points (BPS), and maybe to 75 BPS (3/4%), this year… And all that openness to depositors outside of China that the Chinese have begun to make available, is going to be flooded with new money, and drive the renminbi (CNY) to record levels versus the dollar…

But, that’s not just good for the renminbi… The Singapore dollar (SGD), the Hong Kong dollar (HKD), and other minor Asian currencies will all follow the renminbi higher versus the dollar in 2011… So much for that so-called multi-year dollar rally beginning this year, eh? It won’t be so good for the US consumer, though… Because all that stuff that Wal-Mart, Costco, and whomever else sells from China, is going to cost a whole lot more… Oh, did someone say something about an inflation problem in the US?

So… As I look out over the landscape of the currencies this morning, I have one thought in mind… Buy the commodity currencies on the dips, of which this is one! But then that’s just me, as I say… I could be as wrong as two left shoes!

The precious metals, though… Whoa, there partner! While the currencies were taking liberties with the dollar yesterday, gold and silver did not participate, and instead were sold, and sold in bunches! At one point in the day, I noticed that silver was down over $1, which for silver is a HUGE move! Now, I certainly understand that the “fringe precious metals investors, don’t understand the “real reason” they bought the shiny metals. And I also certainly understand that the successful bond auctions in Portugal, Spain, and Italy this week, lessons the need to own a flight to safety investment. But… The Swiss franc (CHF) is holding serve against the dollar, so why not gold and silver?

The demand around the world for gold and silver remains quite strong, so it’s not a demand problem, as far as I can see… Stories like the one I saw this morning from India – where disposable incomes are rising, and with those new found rupees (INR), consumers buy gold – should underpin gold… But not now… Right now, we’re seeing something that is quite surprising to me… But, since the government bailed out Bear Stearns, GM, AIG, etc., and allowed Lehman Brothers to fail, nothing has made much sense to me with regards to the markets. I hope and pray every day that we will return to a market that is driven by fundamentals… And not media flag waving, and crazy thoughts…

The Brazilian government and central bank (BCB) was at it again yesterday… In their never-ending attempt to keep the Brazilian real (BRL) from gaining value, they spent $1 billion in a currency swap deal… Here’s the skinny on this…

The BCB goes into the markets and gets bids to do a reverse currency swap, which means they sell reals for another currency, let’s say dollars, with an agreed tenor and rate. This way, the BCB isn’t selling the real and not ever getting it back, like most central banks do when they intervene… The BCB will get the reals back at the end of the swap… Today’s reverse swap garnered $1 billion… So, the real, was in reality sold for $1 billion worth of dollars… Who are these guys?! And what are they doing? Well, actually, this is a very shrewd move by the BCB… But the question that comes to mind is simply how many times will the BCB enter this arena?

So… The ECB is noticing inflation pressures… But the Fed/Cartel/Bernank is still chasing deflation ghosts? I’ll tell you right now, I’ll pin my colors to the ECB’s mast, for they understand what all the stimulus, bailout, and bond buying can do to ignite inflation… Our guys? Well… Let’s say that they are in the Japanese camp… They are hoping that they’ll be just like Japan, and not suffer runaway inflation from all their economic cocaine they’ve supplied to the markets.

Speaking of Japan… What a sorrowful lot! They are beginning their third decade under the “no growth” cloud that’s been hanging over them since their stock market bubble burst in 1991… And I guess, when I think about them, what I picture most in my mind is their government going back to the stimulus well, over and over again, along with multiple implementations of quantitative easing, of them keeping interest rates at zero for a very long time, and their building up government debt to unsustainable levels… Hmmm… Wait-a- minute… Just who am I talking about here… Japan, or the US?

The BIG difference here, folks, is that Japanese consumers are savers, not spenders… And what are US consumers? Spenders with a Capital “S”! And while here in the US we’ll be left with the malaise that clings to the Japanese economy, and the unsustainable government debt… We won’t be left with their deflation… (Except in housing!)

And speaking of debt… Moody’s issued a warning to the US again – Moody’s says the US could be placed on negative outlook if a plan to stabilize the debt doesn’t materialize. “We have become increasingly clear about the fact that if there are not off-setting measures to reverse the deterioration in negative fundamentals in the US, the likelihood of a negative outlook over the next two years will increase,” said Moody’s.

The US trade deficit narrowed in December by $ 400 million, not a huge amount, but far below the expectations for December… Hmmm… Doesn’t bode well for next week’s retail sales for December, does it? If our imports weren’t huge, and that’s a good thing to me, then retail sales won’t be huger either… It’s just how I see it, folks…

Speaking of trade deficits… Canada’s trade deficit dropped sharply in December… Canada’s trade deficit unexpectedly narrowed in November on the combination of a sharp decline in imports of energy products and machinery and a modest increase in exports. The trade deficit in November declined to C$ 81 million ($81.8 million) from a revised C$1.48 billion… Now, that’s a deficit reduction!

To recap… The bias to sell dollars reached a fever pitch yesterday, with the euro gaining 2-cents at one point in the day. The dollar selling continued on through the night, until… China announced a 50 basis point (1/2 %) hike of the reserve requirements for their largest banks… This was done to cool down the Chinese economy and rising inflation… The euro stopped its rise in its tracks and retreated. But the commodity currencies did the biggest retreating, as they are closely tied to the fortunes of China…

Chuck Butler
for The Daily Reckoning

The Daily Reckoning