Dollar Edges Back Up

Good day… The dollar edged up overnight as the ISM data showed that U.S. service industries unexpectedly strengthened last month. This report cooled some of the speculation that the Fed will look to cut interest rates next quarter. However, other data released showed that unit labor cost increases have slowed, reducing inflationary pressures in the United States.

So it looks like we are back to what has been termed the ‘Goldilocks economy.’ Growth and inflation are both ‘not too hot and not too cool.’ I continue to believe that Bernanke and his cohorts at the Fed will keep rates right where they are – well into 2007. But more importantly, it now looks like the Fed will be adjusting from a hawkish bias (due to concern with inflation) to a more dovish stance with concerns about growth.

While the most recent data suggests the U.S. economy `is still chugging along, the full effect of the housing market slowdown has yet to be felt. The U.S. consumers will, as always, overspend during the month of December keeping growth and confidence up. But when the bills start rolling in during the first quarter of 2007, these same consumers will have to tighten up; a slowdown is inevitable. In years past, the typical buy now and pay later U.S. consumers were able to ‘consolidate loans’ and ‘put the bills on the house.’ With a weaker U.S. housing market, these refinance opportunities are just not there – leaving many consumers with no choice but to cut back on their spending.

The euro will likely gain some strength today from a report just released, which shows that retail sales growth accelerated in the euro region for a third month in November. The ECB has already signaled that it will raise its key interest rate tomorrow for the sixth time in a year, as consumer spending helps drive economic growth to the fastest pace in six years, increasing inflation pressures.

Chuck emailed me these thoughts on the ECB:

“As you know…I’ve been saying for six months that the ECB would hike rates in December. The recent real activity signals emerging from the Eurozone economy will act as a ‘see I told you so’ by the ECB after they raise the rates today. I still have the light on for over 4% rates in the Eurozone. So that means there are more to come! And with that thought, there will be more strength in the euro.

“No doubt the strong euro will go a long way toward helping fight inflation, and might, just might, you never know, allow the ECB to stop raising rates sooner than they now think they will. But, by then the euro should have so much momentum (and the Fed will have indicated a cut in rates) that it won’t affect the euro too much. But…that’s far down the road in 2007. NANA,NANA,NA,NA, live for today.”

Recent data out of the United Kingdom has worked to stall the pound sterling’s assault on the $2.00 level. A report yesterday showed that sales at U.K. retailers rose at the slowest pace in nine months in November. This morning, a report showed factory production in the United Kingdom unexpectedly fell by the most in a year in October, held down by a stronger pound sterling and a slowdown in the United States. Another report out of the United Kingdom this morning showed consumer confidence slid in November as the BOE’s two interest rate increases this year boosted borrowing costs and sapped demand among British Christmas shoppers.

Any weakness in the pound sterling will likely be reversed later this week, as we expect the BOE to continue to project a hawkish tone after their rate meeting tomorrow. While U.K. consumers seem to be concerned about the future of the economy, a recent report showed that U.K. service industries growth accelerated in November to the fastest pace in almost three years. I don’t expect the BOE to raise rates at their meeting tomorrow, but I do think they will leave the door open for further rate increases in the beginning of 2007, which will likely drive the pound back toward $2.00.

Both the Bank of Canada and Australia’s central banks kept their benchmark interest rates unchanged last night. The markets expected these moves, so they did not have a major impact on the respective currencies. Both central banks feel their economies are ‘balanced’ with inflation expectations offset with slowing growth. While the two central banks made similar decisions, we still feel the Australian dollar has much better upside potential. The Canadian economy is still closely linked to the United States, and with an expected slowdown here in the states, we fear the Canadian dollar has probably seen its peak. The Australian economy, on the other hand, sends much more exports into the rapidly expanding Asian markets. Commodity exports should keep the Australian doller well bid giving the currency a real possibility of finally moving above the 0.80 level it has bounced off of in recent years.

We will have a break in data today, as the mortgage applications are the only scheduled release. The currency markets will likely take their cue from yesterday with the dollar drifting up before the big ECB rate announcement tomorrow.

Currencies today: A$ .7858, kiwi .6838, C$ .8749, euro 1.3286, sterling 1.9665, Swiss .8366, ISK 69.08, rand 7.1182, krone 6.1199, SEK 6.8299, forint 192.35, zloty 2.8636, koruna 21.08, yen 114.97, baht 35.67, sing 1.5398, HKD 7.7681, INR 44.70, China 7.8234, pesos 10.87, dollar index 82.71, Silver $13.63, and Gold… $636.45

That’s it for today… I had a great time watching the #16 jersey of Brett Hull being raised to the rafters last night. This is the first time ever that a father and son both have had their numbers retired by their respective club. Both Kristin and Christine brought in Starbucks this morning; we are going to have an Extra Wired Wednesday. Happy St. Nicholas Day to everyone!

Chuck Butler
December 6, 2006

The Daily Reckoning