Data Supports ECB's Decision to Hold Rates Steady

Good day… Another winter storm is set to hit St. Louis today, bringing a couple of inches of ice and snow to add to the three inches of ice we received yesterday. There were several times it looked like we were going to need to shut the desk down early and get out of here, but we hung in and stayed until the closing bell rung. Several of you didn’t get your Pfennigs in a timely manner again yesterday. I can only apologize for our technical problems and suggest readers continue to go to our website to read it in a timely fashion. Our technical team tells me they have elevated the fix for our email server and will hopefully get the problems worked out soon.

The dollar fell throughout the day Thursday with the euro (EUR) running up above $1.48. The employment data in the United States was a non-event, as jobless claims came in just as expected, but the volatile Phily Fed Index dropped 24 points, over twice as weak as expected. More importantly, the leading indicators – a measure of the economy’s future performance – declined for a fourth month. This data is just another indication that the U.S. economy is in a recession, which brought the rate cut talk back out in force. The FOMC continues to be more concerned with the growth of the U.S. economy, and will likely turn a blind eye to all of the inflation warnings that have been showing up all over the data. I still look for our Fed to cut rates again at their next meeting, a cut that will enable traders to continue their assault on the U.S. dollar.

And the markets agree with me. Speculation that the Fed will cut rates to stave off a recession while European policy makers keep rates on hold sent the euro to over $1.485, the best level since the first day of February. In fact, the euro has been steadily rising over the past two weeks, after it traded below $1.4450 after Trichet expressed concerns that the outlook for growth had deteriorated. But a report released yesterday showed that growth in Europe’s service industries accelerated more than economists forecast in February, prompting investors to reduce bets on ECB interest rate cuts.

Much of the data coming out of the Eurozone lately is indicating that economic growth in Europe is holding up, which reduces the need for the ECB to follow the lead of the United States and the U.K. and cut rates. The ECE did cut its forecast for the region’s 2008 expansion to 1.8%, the weakest since 2005, but it also predicted accelerating inflation. Trichet and the other voting members of the ECB have held off lowering interest rates as inflation accelerated to a 14-year high of 3.2% in January. The latest data looks to push back any chances for a rate cut as inflation continues to be their main concern.

Rate differentials have also supported two of Chuck’s favorites, the Norwegian krone (NOK) and Swedish krona (SEK). Both the NOK and SEK have gained recently, as commodity exports rose to record highs. Deutsche Bank agrees with Chuck’s sentiment, as they stated that both these Scandinavian currencies will ‘perform best’ as global expectations rise. According to the head of currency strategy at Deutsche Bank, Bilal Hafeez, “Commodity linkages and central banks who act on inflation concerns are the necessary ingredients for increasing inflation risk to be positive for a currency.” In other words, those central banks that are aggressive with interest rates to combat inflation, and have a commodity driven economy, will outperform all other currencies in 2008. Sounds like he has been eating what Chuck’s been cooking!!

Two other currencies that fit this inflation fighting/commodity exporting description are the Australian (AUD) and New Zealand dollars (NZD). Both headed for a second weekly gain on optimism, the interest rate advantage of the two nations over the United States will widen. These two currencies are the second and fourth best performers versus the U.S. dollar this month. Traders increased bets that Australia’s central bank will raise rates a quarter point next month while rates are likely to be cut in the United States. The real risk on both of these currencies lies in their attractiveness as investments for the ‘carry trade’. We have seen the impact of a reversal of the carry trade on these currencies a few times last year, and a further reversal could send them down again; but the commodity exports and higher rates should mitigate much of this risk. The Aussie dollar continues to be one of the most popular investments here at EverBank.

Two other currencies that have been on a tear versus the U.S. dollar recently are the Brazilian real (BRL) and the Singapore dollar (SGD). The Brazilian real advanced to the highest in almost nine years, and Singapore’s dollar reached a decade high. I wrote a few paragraphs on the Brazilian real earlier this week, so I will spend some time on Singapore today. Asian countries such as China and Singapore are trying to control faster inflation and have been more open to stronger currencies in their battles. Economic fundamentals are also much better than here in the United States. The Singapore dollar rose as the central bank allowed slightly faster appreciation to lower import prices and curb inflation. The currency had a second weekly gain before a government report next week that economists forecast will show that consumer prices climbed by the most in a quarter century. The Monetary Authority of Singapore said last October that it would ‘increase slightly the slope of the policy band’, central bank parlance for ‘we will let the currency appreciate’. We look for the Singapore dollar to be one of the stars of the Asian currencies this year.

Currencies today: A$ .9231, kiwi .8064, C$ .9895, euro 1.4827, sterling 1.9665, Swiss .9202, ISK 66.74, rand 7.7345, krone 5.3233, SEK 6.2757, forint 178.26, zloty 2.4096, koruna 16.87, yen 107.06, baht 31.30, sing 1.4059, HKD 7.7959, INR 40.035, China 7.1422, pesos 10.7948, BRL 1.7056, dollar index 75.472, Oil $99.03, Silver $17.90, and Gold… $945.88

That’s it for today…Hopefully this Pfennig will reach everyone in a more timely fashion than the past few. As I said above, another wintry mix of ice and snow is expected for today. The kids are excited, as they have another snow day (they forget that they will have to make these days up in the heat of summer!). Hope everyone has a Fantistico Friday!!

Chuck Butler
February 22, 2008

The Daily Reckoning