Data Confirms U.S. Slowdown

Good day… Data released yesterday morning confirmed that the U.S. economy is continuing to slowdown, as the conference board reported the index of leading economic indicators fell 0.5% in February. The index fell a revised 0.3% in January, compared with a 0.1% gain originally reported. This index has risen just twice in the past six months and is designed to forecast turning points in the economy, six to nine months out.

This negative economic data was somewhat offset by the weekly employment data, which showed that jobless claims fell by 4,000 to 316,000, the lowest since the week of February 13. Initial claims had risen to a 17 month high in early March, so the markets were somewhat relieved by the better figures. The decline reinforced the assumption that the February economic indicators were subject to considerable weather distortions.

But don’t let these rosy employment figures fool you. The thing to remember is that the employment numbers are backward looking, while the index of leading economic indicators is forward looking. Unemployment will respond to slower growth with the usual lags, and the jobless rate should begin to tick higher in coming months.

The housing slowdown is going to really start impacting the employment picture as we move into what is usually a strong construction season. Compared with the same time last year, initial claims are up about 4%, while continuing claims are up about 3%. Of the 6.9 million officially unemployed people, 31% have been out of work longer than 15 weeks and 18%, or about 1.2 million, have been out of work longer than 27 weeks. And this doesn’t even consider all of those who have fallen off of the roles since they are no longer looking for work.

So you would think the data would have led to additional selling pressure for the U.S. dollar, right? In what has become typical, the currency markets reacted contrary to how logic would dictate, and rallied slightly in the afternoon. Since I wasn’t on the trade desk yesterday, I was struggling to figure out what could have driven the dollar up. Ashish Advani, our Corporate FX guru came to my rescue with an email he sent me late yesterday afternoon:

“End of day, fundamental picture for growth and inflation really hasn’t changed, so positions drive the market more than much else. The rally up in the U.S. dollar may really reflect the bond side that is moving thanks to the Fed statement as well – as yield curve steepeners continue.

“Euro or yen moves today are not sufficient to negate the technical picture of the long-term U.S. dollar pain – nor can we ignore what the inflation implications from yesterday. Markets are undecided as to whether the lower risk of interest rates moving up, as indicated by the Fed, is good or bad. It could be good if the markets do not expect that the Fed’s move up and growth is up in moderation [Goldilocks]; but it could be bad if the markets wonder what the Fed knows that they don’t, in order to make their bias change to lower chances of moving rates up. So what is going on right now appears to be an opportunity in the on-going storm of risk adjustment and trend.

“Gold and oil are flashing some clear signals about inflation risks. It could be that the market is repricing the happy slowdown – and the next leg to drop for the United States will be back to equities as bonds move to yield levels that push the risk back to questioning the returns available in the future. There remain other stories that matter – geopolitical worries which some may point to, as well for the oil move. North Korean talks are failing to add to this mood, and provide yet another reason for medium term caution about the U.S. dollar.”

So the slight move up by the dollar was likely due to position adjustments and foreign investments into the short-term U.S. treasuries. As Ashish points out, the overall picture continues to be negative for the dollar.

The Fed’s chief bank supervisor admitted he should have acted faster to prevent a meltdown in the subprime mortgage market by curbing the lax lending standards that contributed to the crisis. “Given what we know now, yes, we could have done more sooner,” Roger Cole, the Fed’s director of banking supervision and regulation, told the Senate Banking Committee in Washington, as regulators testified for the first time before Congress on the market rout.

In typical fashion, lawmakers called a hearing on the subprime meltdown to figure out who (besides themselves) were to blame. In a move that epitomizes the term “better late than never”, the Fed, FDIC and other U.S. regulators on March 2 directed banks to scrutinize underwriting standards, provide more information to customers about borrowing risks and ensure that borrowers are able to repay loans.

As Chuck has pointed out numerous times, this subprime meltdown will have far reaching implications for the U.S. economy. In my opinion, the next big news will be a jump in consumer bankruptcies. If the Feds are giving the subprime lenders trouble about lax lending standards, they need to take a look at the credit card companies! I receive several “pre-approved” offers in the mail each week telling me I can have several thousands of dollars in credit simply by signing the enclosed application.

But while these offers go straight to the shredder in my house, many individuals have trouble turning the “free” credit down. The U.S. consumers are digging themselves into a very deep hole of debt, and as with any type of economic slowdown, I have to believe consumer bankruptcies are going to skyrocket. It isn’t shaping up to be a very pretty picture for the U.S. economy. Just another reason to move at least a portion of your investment portfolio out of the U.S. dollar.

Good news out of London should prove to keep the pound sterling well supported. U.K. Chancellor of the Exchequer Gordon Brown announced plans to cut both personal and corporate taxes in what’s likely to be his final budget address before becoming prime minister. Brown predicted that the U.K. economy would grow between 2.5% and 3% in 2008 and 2009, making it the fastest growing economy in the G7.

Inflation, which was 2.8% in February, is expected to drop back to the 2% target by the end of the year. Brown is likely to take over for Tony Blair when he steps down as prime minister, a move expected within a few months. General elections are not required in the United Kingdom until 2010. All of this is good news for the pound, which continues to be a good secondary investment to the euro.

The big news out of Japan was the release of a report showing that Japanese land prices rose for first time in 16 years, as overseas and domestic investors competed to acquire properties in the country’s three biggest cities. Gains in Tokyo, Osaka and Nagoya compensated for a drop in regional areas. Average commercial land prices in the three cities rose 8.9% and residential 2.8% in the year ending December 31, the Ministry of Land, Infrastructure and Transport said in report released yesterday.

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Bank of Japan Governor Toshihiko Fukui on March 20 said that policy makers would consider land prices and currencies when considering whether to raise its 0.5% interest rate. So this increase in real estate prices will likely put additional pressure on interest rates. The yen still headed for a weekly drop against the dollar though, as investors restarted the carry trades, borrowing yen to invest in higher yielding currencies. As we have seen in the past, these carry trades can be reversed very quickly, moving the yen higher in dramatic moves.

Finally, the dollar may weaken today before a U.S. report forecast to show that sales of previously owned homes declined last month to an annual rate of 6.30 million, from 6.46 million in January, according to a Bloomberg survey. Just another report confirming what we already know, the United States is heading for an economic slowdown.

Currencies today: A$.8068, kiwi .7140, C$ .8635, euro 1.3322, sterling 1.9650, Swiss .8238, ISK 66.46, rand 7.1957, krone 6.0986, SEK 6.9873, forint 184.985, zloty 2.9074, koruna 21.00, yen 117.625, baht 31.85, sing 1.5159, HKD 7.8118, INR 43.57, China 7.7290, pesos 11.002, Silver $13.37, and Gold $662.15

That’s it for today… In all of the hassle of getting the Pfennig out from a remote location (dial up speeds are a real problem!) I forgot to wish Chuck a happy birthday! After a quick flight to Florida, Chuck got to spend his birthday watching his beloved Cardinals with his family. I’ve had Chuck as a friend for almost 20 years now and I know that there is nothing he would rather be doing on his birthday. Happy Birthday Chuck, and have an ice cold Bud for me!! GO CARDS!

Chuck Butler — March 23, 2007

The Daily Reckoning