Dollar Bears Have The Con

Good day. The dollar continued to sell off yesterday, in spite of economic releases that showed the U.S. economy powering ahead in March. Orders for durable goods rose 6.1 percent, more than three times the median forecast of economists. New home sales increased 13.8 percent, the most since April 1993, to an annual rate of 1.213 million. This data should have caused the dollar to gain back some of the losses it has had over the past few weeks as these numbers indicate the economy is still running well above expectations. This data, combined with Tuesday’s consumer confidence numbers, which came in at a four-year high, would certainly indicate that the FOMC has plenty of room left to continue to raise interest rates.

So, why didn’t the dollar gain? Currency traders are no longer focusing on short-term interest-rate moves in the United Sates. While some may believe the Untied States will now raise rates another two times instead of just once, they also know the ECB will be making multiple moves up over the next year, narrowing this interest rate differential. The tone of the market is currently dollar-negative and good data from the United States will be overlooked, just as negative data was swept aside during last year’s dollar rally.

As Chuck told the desk last night before heading down to Mexico, “I see the dollar going into a real bear market right now. Two separate pieces of data (durable goods, and new home sales) came in stronger than expected, and the dollar could not sustain a rally. In fact, it eventually got sold off as we went through the day! That spells B-E-A-R market.”

The tone out of the ECB continues to become more hawkish, with several council members now calling for more aggressive action on interest rates to protect against inflation. ECB member Nicolas Graganas had this to say at a press conference yesterday:

“We have to expect more interest-rate increases. The current benchmark rate of 2.5% is still at a historically, excessively low level and very far from the normal level. The pace of further increases will hinge on economic developments.” Graganas is the sixth policy maker this week to signal that the ECB is poised to raise interest rates on concern that faster growth and the 17 percent increase in oil prices this year, will push up inflation.

Recent data out of Europe looks to support a more aggressive approach to interest rate increases. This week, at least six government reports and industry surveys showed that economic growth is accelerating in euro nations. Highlighting these reports was one that showed German unemployment dropped in April, and another that showed business confidence in Germany reaching a 15-year high.

Clearly, the ECB is only at the beginning of its rate cycle, and it’s likely that Trichet will express the intention of continuing rate increases at the next meeting on May 4, 2006.

Fed Chairman Ben Bernanke will testify on the U.S. economic outlook before the Joint Economic Committee of Congress today, but don’t expect him to move the markets. Unlike Greenspan, who ran monetary policy as a one-man show and liked to move the markets with his veiled messages, Bernanke’s approach is more rule-based and depends more on the central bank’s forecast, which is already public.

In the summary of the most recent FOMC meeting in March, the Fed said that it expected growth to moderate later this year and the core inflation was expected to pick up before stepping back down in 2007. While the most recent data shows the U.S. economy still powering ahead, the Fed is still expecting this growth surge slow down. So, while everyone will be watching for signals from Bernanke, I don’t expect him to say anything that will ‘move the markets.’

The Canadian dollar set a 14-year high on speculation the Bank of Canada will keep increasing interest rates to curb inflation in an economy benefiting from surging commodity prices. As we have been pointing out over the last several years, Canada has been developing closer trading ties with Asia in order to break from its dependency on the United States. With commodity prices reaching record levels, the Canadian economy continues to surge forward.

We aren’t the only ones suggesting investments in the loonie. ABN Amro now believes Canada’s dollar will strengthen to an almost three-decade high against the U.S. dollar, this year. “A long series of multiple rate hikes are needed as the economy faces capacity constraints,” said Peter Frank, a Chicago-based senior currency strategist with ABN Amro. Frank predicted the loonie will rise to 1.05 CAD$/US$ or .9524 U.S. cents by the end of this year. And, he believes it will move to 1.02 CAD$/US$ or .98 U.S. cents by the end of 2007. Go Loonies!

We got a rate increase from down under, but it wasn’t from the expected source. The Reserve Bank of New Zealand left interest rates at their current levels, and Reserve Bank Governor Alan Bollard gave no indication of future interest rate increases in the accompanying press release. Bollard stated, “Monetary policy remains focused on ensuring that inflation settles back within the 1-3 percent target band over the medium term. We still do not expect to raise interest rates again in this cycle. However, monetary policy must remain vigilant against these price shocks spilling over into inflation expectations.” The kiwi strengthened slightly on the news.

China surprised the markets, raising its benchmark interest rate for the first time since October 2004 to cool the world’s fastest growing major economy. The objective of this interest rate increase was to slow down investment growth and loan growth, which was higher than the target set by the government. This move was unexpected, as it may harm the government’s plans to boost domestic consumption. China’s government is seeking to bolster consumer spending to help make the economy less dependent on exports and investment for growth. Rising spending by the “new middle class” in China would also help bolster imports, potentially reducing the trade surplus that has caused friction with the United States.

While the Chinese held the currency peg steady after the release, the Japanese Yen and other Asian currencies rose on the news. This move adds to the impression that Asian central banks are going to be prepared to raise rates, and ultimately allow more strength in their currencies. We continue to expect Japan to start increasing interest rates later this year, ending their long “zero-rate” policy. Asian currencies continue to be among the most under valued in the world. As interest rates increase in these countries, we expect these currencies to move back toward their true value. Look for the yen, Thai baht, and Singapore dollars to continue to turn in some of the best performances versus the U.S. dollar.

Now on to the big finish:

Currencies today: A$ .7507, kiwi .6295, C$ .8854, euro 1.2428, sterling 1.7840, Swiss .7857, ISK 74.22, krone 6.26, rand 6.1815, forint 213.51, zloty 3.1175, koruna 22.89, yen 114.64, baht 37.61, sing 1.5859, INR 45.03, China 8.0163, pesos 11.13, dollar index 87.37, silver $12.44, and gold $632.20

That’s it for today. Hope everyone has a great Thursday!!

Chris Gaffney
May 1, 2006

The Daily Reckoning