Credit Fears Ease

St Louis, Missouri- Good day… And welcome to what should be another volatile week in the markets. Credit worries eased somewhat over the weekend, which helped push money back into the higher yielding currencies. Today, Federal Reserve Chairman Ben Bernanke will head to Congress to share his views on the economy. Should make for a pretty interesting day of trading. Hope you are sitting down and holding on; it looks like we are going to take another lap on the currency roller coaster!

The yen (JPY ) fell over the weekend as investors began moving funds back into the higher yielding currencies of Brazil (BRL ), Mexico (MXN ), New Zealand (NZD ) and Australia (AUD ). I won’t go into the whole explanation of the carry trade again, but suffice it to say that these moves haven’t proven to possess much staying power. But I do like the news that the credit markets may be calming down a bit after the government moves to shore up the big international banks.

European Central Bank President Jean-Claude Trichet urged banks to start lending again after policy makers put them “on the path” to recovery. Trichet said in an interview yesterday that the banking system is “on the path to normalization” after governments pumped record amounts of cash into money markets. The three-month Libor rate for dollars fell every day last week, and this morning we saw another drop in the rate – an indication that the credit markets are continuing to thaw out. “We’re facing a very important market correction which is lasting,” Trichet said, hinting that the credit crisis may be coming to an end.

Today I expect the international markets to focus on Fed Chairman Bernanke’s testimony to the House Budget Committee. While I don’t expect Big Ben to come totally clean on the dire economic situation facing the United States, I would expect him to warn Congress that a rebound in U.S. growth won’t happen right away, and that losses on mortgage derivatives will continue to impact the credit markets. His pessimistic comments on the economy will likely move the dollar even lower versus the major currencies, as the focus moves back to the United States where we are most certainly in a recession.

Chuck was busy this weekend on the road with FXU, but took some time to send me these thoughts to share with all of you:

“A Marvelous Monday to you!

“I gave a speech on Saturday in Fort Lauderdale, and tried very hard to get people to listen carefully about what I was telling them. And what I was telling them was that the U.S. debt generation is out of control… Then I saw this info that a reader sent along, that played well with my speech from the pulpit…

“‘From September 30, 2007 to the end of this past fiscal year on September 30, 2008, total federal debt grew by $1.0 trillion, from 9,007,653,372,262.48 to $10,024,724,896,912.49, which is an 11.3% annual rate of growth. The federal debt, as of October 16, 2008, is now $10,331,139,000,845.92. So in just 16 days since the end of the last fiscal year, the federal debt has grown by an astounding $331.1 billion, which is a 75.5% annual rate of growth. It has taken just 16 days to borrow one-third of what the government borrowed in all of last year.’

“So… The National Debt clock needs to be replaced, because it doesn’t have enough digits to deal with $10 trillion dollars of debt! So… I thought I would give you two thoughts that I read out loud to the audience in Fort Lauderdale. These come from the book, I.O.U.S.A. by my friends, Addison Wiggin and Kate Incontrerra. The first piece is from Ron Paul… The second from Warren Buffett regarding debt…

“‘Ron Paul: “We can’t afford to pay all these bills, and if we just pay for these bills by printing money, it will destroy the currency – and that will be a much, much more painful reaction than us just tightening our belts and living within our means.”

“‘Warren Buffett: “I do think that piling up more and more and more external debt and having the rest of the world own more and more of the United States may create real political instability down the line and increase the possibility that demagogues come along and do some very foolish things.”‘

“Now folks, you know me… I have always railed on the United States for building up these debts – budget, national, etc. But after reading the book, and seeing the movie I.O.U.S.A., I have to tell you that what I’ve been fearful of was chickenfeed compared to the information that both the book and the movie have, regarding debt! Put away the sharp objects folks… This stuff is scary… But Real!

“So… We can go along now, and the repatriation and LIBOR currency swaps can build up the dollar… But, the way we’re headed, we have no other choice as a country than to allow our currency to devalue so that these debts, and interest on these debts be paid in the future with cheaper dollars!

“I just saw that South Korea announced a plan to put $100 billion towards a guarantee to foreign currency debt and a $30 billion injection (from FX reserves) (see how nice it is to have reserves?) to the banking sector.

“This lit the light bulb over my head! Could this be the key that unlocks the intense demand for dollar funding, which has fueled the dollar rally? (Recall, when I told you about this dollar funding on currency swaps because of the out of whack LIBOR?) Well, this is what I’m talking about here… Another good sign last week was the drop, albeit baby step drop, of LIBOR last week. If this can continue, and the banking sector no longer has to go to the currency swap market for funding, we could see the dollar lose some of its steam…”

New Zealand officials are working on a plan to guarantee wholesale deposits at the nation’s banks, according to Finance Minister, Micheal Cullen. New Zealand last week guaranteed retail deposits to bolster confidence in their financial institutions. These moves by South Korea and New Zealand follow similar moves by countries across the globe. These guarantees look like they are working, as credit markets have eased a bit and money is moving back into the higher yielding currencies. As risk aversion eases, the currencies of New Zealand, Australia, Brazil and Mexico are likely to benefit. All four of these currencies are up nearly 1% versus the U.S. dollar as a result of these moves.

Producer prices in Australia rose in the third quarter twice as fast as economists expected, which may stoke speculation that central bank Governor Glenn Stevens won’t repeat this month’s decision to cut benchmark interest rates. The producer price index advanced 2% after rising 1% in the second quarter, the Bureau of Statistics said in Sydney today. Traders are still betting on another interest rate cut at the next meeting on November 4, but the size of the cut is now expected to be just 50 basis points compared to the last cut of 100 basis points. The prospects for further aggressive cuts by the central bank have been reduced by the jump in producer inflation. Hopefully the Aussie dollar will continue to climb back up, as we are seeing a lot of support around the 0.69 level. A further rally in gold and other commodities would also help the Australian currency.

India’s central bank unexpectedly lowered its key repurchase rate for the first time since 2004 in response to the global credit market turmoil. The Reserve Bank of India cut its overnight lending rate to 8% from 9% today. The move signals that Governor Subbarao sees weaker growth as a bigger threat than inflation in Asia’s third largest economy. China’s economic growth slumped to a five-year low last quarter and growth in India has been declining also. The Indian rupee (INR ) is Asia’s third worst performing currency this year, and may fall to a record low of 50 per dollar by year-end according to currency strategists at France’s Credit Agricole. A research report predicted the currency, headed for its biggest annual loss in 17 years, is one of the most vulnerable in the region to the falling appetite for risky investments. The currency has continued to fall, as investors have pulled out nearly two-thirds of the $17.4 billion they invested in Indian stocks last year.

As mentioned above, China’s economy expanded at the slowest pace in five years, as the financial crisis cut demand for exports. But before everyone gets too worried about the shutdown of the Chinese economy, gross domestic product rose 9% in the third quarter from a year earlier. Nine percent doesn’t sound like too much of a slowdown to me! And China will continue to cut internal interest rates to keep growth near the current levels. Predictions of an even greater drop in Chinese growth has helped push commodity prices down. If China can continue to grow at near double-digit rates, demand for iron ore, copper, and oil will remain strong. Currencies such as the Australian dollar, which depend on commodity exports, will rebound with a rebound in these commodity prices.

Currencies today 10/20/08: A$ .6935, kiwi .6129, C$ .8446, euro 1.3403, sterling 1.7390, Swiss .8781, ISK 260.0, rand 10.10, krone 6.5672, SEK 7.3810, forint 199.61, zloty 2.668, koruna 18.63, yen 101.75, baht 34.28, sing 1.4792, HKD 7.7563, INR 49.01, China 6.8299, pesos 12.8049, BRL 2.106, dollar index 82.52, Oil $73.81, Silver $9.763, and Gold… $798.32

That’s it for today…What a gorgeous weekend here in St. Louis; perfect fall weather. The Mizzou Tigers barely showed up in Austin this weekend and now they will have to try and battle through the rest of the season hoping for a rematch with Texas at the Big 12 Championship. The Blues and Rams both had big wins this weekend in some pretty exciting games! Hope everyone has a great week and a Marvelous Monday!!

Chris Gaffney
October 20, 2008

The Daily Reckoning