Continued Concern Over Inflation

Good day…We had fairly quiet markets on Friday, as they seem to be range bound waiting for a piece of data to break them out. Looking at the data due out this week, I don’t expect much movement until Thursday or Friday. We only have the release of Leading Indicators this morning, ABC Consumer Confidence tomorrow, and MBA mortgage apps on Wednesday. Thursday we will finally get some meaty U.S. data with the release of Existing Home Sales along with the weekly jobs numbers. Friday we will end the week with Durable Goods orders and New Home Sales.

The U.S. dollar rallied a bit in Europe this morning as U.S. Fed officials seemed to be singing from the same song sheet regarding inflation. At the end of 2006 it seemed inflation was the least of our worries, with a free falling housing market and mounting debt/deficits. The currency markets took advantage of this dovish environment to sell the U.S. dollar.

Lately Federal Reserve policy makers, confident that signs of a pickup in growth mean the economy will weather the housing slump, are showing little indication of relaxing their concern over inflation. On Friday, we had the Kansas City Fed chief Thomas Hoenig following Richmond Fed Bank President Jeffrey Lacker in calls for concern over inflation. As regular readers know, Lacker is probably the biggest inflation hawk currently on FOMC and it looks like he is finally winning over some of his compatriots. The dollar has continued to rise this morning before a speech on the economy today by Federal Reserve Bank of San Francisco President Janet Yellen.

The U.S. dollar rose for a sixth day versus the yen as traders have reduced bets that the Fed will lower interest rates in the first half of 2007. If the numbers out at the end of the week show that durable goods orders have increased and home sales have stopped weakening, look for more dollar strength. While I can see where the durable goods orders could come in stronger than expected, I don’t see where anyone could be expecting the housing numbers to be up.

Both U.S. Treasury secretary Lawrence Summers and ECB President Jean-Claude Trichet are warning the more than 2,200 movers and shakers at the 37th World Economic Forum in Davos (so that’s where Chuck is!) that they have become too complacent about risks in today’s economy. A glut of cheap money and the strongest global economic growth in three decades have encouraged banks, private-equity firms, and hedge funds to bet that the good times will keep rolling. Both Summers and Trichet are trying to keep these investors aware of the risks which have been building over the last few years; namely the huge global trade imbalances being created by weakness of the Asian currencies.

The pound sterling continues to gain versus the euro and U.S. dollar after reports showed house prices rose in January and the economy will expand this year at the fastest pace since 2004. The pound has gained almost 2% since policy makers boosted U.K. interest rates on January 11. With a hot housing market, currency traders are speculating the need for further rate increases.

The economy in England is expected to expand 2.9% in 2007, up from 2.7% last year. Stubborn inflation, which has held above the BOE’s goal of 2%, will likely force another rate increase this quarter. While the $2.00 threshold will be a tough one to break; another rate increase could be just the boost the pound needs to get above it. I expect us to see the sterling test the $2.00 level as early as February and should break through in March.

Standard & Poor finally had some positive things to say about a Nordic economy, but not about Iceland. S&P said Sweden’s cuts in taxes and welfare benefits have increased the potential growth rate of the largest Nordic economy to 3.4% in 2007. They kept their top AAA credit rating on the nation’s debt and stated, “Reforms proposed in the 2007 budget will further strengthen public finances in the medium term by increasing the tax base and lowering the numbers supported by social welfare benefits.” The Swedish krona was the best performing currency of 2006, rising 15.89% versus the U.S. dollar. While we offer individual SEK WorldCurrency CDs, it is also 20% of our EuroTrax Index CD. We continue to suggest investors have some exposure to the Swedish currency in their portfolios.

China’s economic expansion probably slowed for a second quarter as the government curbed lending to avoid investment bubbles and sought to move their economy toward a consumption environment. GDP grew 10.2% in the fourth quarter from a year earlier, according to the median estimate of economists surveyed by Bloomberg. The government will officially release the growth figures on January 25 in Beijing. Premier Wen Jiabao is seeking to boost consumer spending by cutting a national savings rate that is double the world average. Letting the Renminbi appreciate sure seems like it would be a good step toward moving the Chinese economy toward consumption.

Currencies today: A$ .7899, kiwi .6971, C$ .8510, euro 1.2947, sterling 1.9756, Swiss .7997, ISK 69.67, rand 7.09, krone 6.4548, SEK 7.043, forint 194.10, zloty 2.9682, koruna 21.48, yen 121.68, baht 35.35, sing 1.5381, HKD 7.8019, INR 44.19, China 7.7759, pesos 10.87, dollar index 84.98, Silver $12.86, and Gold… $635.10

That’s it for today… We got another quick shot of winter here in St. Louis this weekend with about four inches of snow. I had a great time riding down the hill in our backyard with my two kids! Hope everyone has a great start to their week; mine is starting out terrific as Kristin brought me a Venti Starbucks!! Have a great Monday!

Chuck Butler, January 22, 2007

The Daily Reckoning