Dollar Trades in a Tight Range

Good day… I’ll start today’s Pfennig with a quick report on Chuck. Thursday turned out to be a great day, as Chuck’s surgery went well and he is now recuperating in the hospital. He is in a lot of pain, but the surgeon did a terrific job taking the kidney out and Chuck is doing as well as can be expected. He will have to spend Father’s Day in the hospital, but should be back home sometime early next week. Who knows, maybe he will feel good enough to pound out a Pfennig or two sometime soon!

The U.S. dollar stuck in its recent range yesterday even after producer prices rose more than forecast. The increase in PPI reflected the fourth consecutive jump in fuel prices that will undoubtedly foreshadow a broader pickup in inflation. Core prices, excluding fuel and food (who really needs to drive or eat?) only climbed 0.2% which is pretty much in line with what the FOMC has predicted.

Attention is now focused on this morning’s CPI data, which will likely show another increase. As I see it, this data will confirm that inflation (as under reported by our government) is slowly rising. The possibility of higher inflation will continue to keep the Fed from raising rates, while the eminent housing meltdown will keep them from raising rates. The FOMC has their hands tied, and they are just going to have to sit back and watch what happens, along with the rest of us.

While the FOMC isn’t going to be able to do anything with rates, Bernanke will still be able to try and jawbone the markets with his comments. As I reported earlier this week, his predecessor, Alan Greenspan, has been doing a lot of talking about the current state of the U.S. economy lately. One of the lead stories on Bloomberg overnight was how Greenspan and PIMCO’s Bill Gross have been debating the direction of the U.S. economy. Gross, the manager of the world’s largest bond fund, says the U.S. housing is in such perilous shape that the Fed may need to cut interest rates in six to nine months. Greenspan, on the other hand, says the odds are 2 to 1 that the economy will avoid a downturn, and that the subprime loans are just a small part of the outstanding mortgages. While I respect Alan Greenspan’s knowledge, I am siding with Gross on this one. And recent data back his assertion that the housing market will continue to drag down our economy.

Yesterday I read a report that showed the number of Americans who may lose their homes because of late mortgage payments rose to a record in the first quarter. These U.S. mortgages entering foreclosure were led by subprime borrowers who were pinched in an economy that grew at the slowest pace in four years. But wait a minute, the Fed’s beige book said that the economy was turning the corner, and the fears of the mortgage meltdown were overblown. Tell that to the subprime mortgage holders. The rate of subprime loans entering foreclosure in May rose to a five year high, and even the prime loan foreclosures hit a record. The median home U.S. home price will likely fall this year for the first time since the Great Depression. Tumbling prices make it difficult for people who fall behind in loan payments to escape foreclosure by selling. Unfortunately, the Fed’s beige book only had it partially right. The housing market may be turning a corner, but it is the continuous corner of a death spiral.

European inflation remained below the ECB’s 2% target for a ninth month in May as a drop in oil reduced transport costs. CPI in the 13-nation euro region increased 1.9% from a year earlier, the same inflation rate as in April. Despite this good news on inflation, I still expect the ECB to continue to raise rates as they wisely try to stay ahead of the inflation curve. Inflationary risks remain from a labor market, which is nearing capacity. Payrolls rose at the fastest pace in three quarters in the first three months of this year. So what does this mean for the euro (EUR), well higher payrolls with low inflation equates to a stronger economy and should move the euro back toward 1.37 and above.

The yen (JPY) fell to its weakest in 4.5 years against the dollar and approached a record low against the euro as BOJ Governor Toshihiko Fukui said the central bank will raise interest rates gradually. No kidding!?! A 0.25% raise every couple of years is about as gradual as you can get. The BOJ’s reluctance to move rates higher gave new support to the carry trade as investors continued to borrow yen. Fukui said he is unconcerned about the yen’s drop as it isn’t a risk for the economy. Well it may not be a problem according to the BOJ, but the Europeans have joined the United States in calling for something to be done about the undervalued yen. While Chinese renminbi (CNY) has been in the world’s spotlight as the most undervalued currency, the Japanese yen is the choice for the carry trade. The low interest rates in Japan have been the major contributor to the glut of liquidity that has flooded the markets and created massive global imbalances.

House Speaker Nancy Pelosi has weighed in on the debate over what to do about China’s massive trade surplus. Pelosi said that she has been warning about the U.S. trade deficit with China for the last 17 years and now the impact on U.S. manufacturers from the weak renminbi is attracting the attention of her colleagues. “Congress will step in,” Pelosi said in an interview on Bloomberg Television. I’m sure everyone feels better about the situation in China now that our great congressmen and women are stepping in! Just look what they have done with the subprime mortgage mess or the immigration debacle here in the United States. Now they are going to go against the wishes of our Treasury Secretary who is a pretty smart guy from Wall Street and try and put tariffs on Chinese imports.

As we have said over and over in the Pfennig, trade wars are not good for anyone involved in them. I believe China will continue to slowly move their currency up no matter what we say or do. Their economy still could not withstand a 15% or even a 10% overnight revaluation. And now the Chinese government is being all but forced into raising interest rates by their growing economy. While they are still an exporting nation, the middle class of China is growing, and they continue to become more and more of a consumer economy. Placing tariffs on imports from China is not, in my opinion, the right way to get China to succumb to our desires. Higher interest rates in China will help cool the Chinese stock market and should make it easier for China to let the renminbi appreciate. I say let the markets force the value of the renminbi up, and have our congress stick to trying to clean up the problems right her in the United States.

So what does all this mean for investors? Well first of all, it illustrates the importance of having a well-diversified portfolio. Asset classes, which are not dependent on the U.S. consumer, need to be represented, including the metals and currencies. I still say the easiest way to hold gold or silver is through our metals select pooled accounts, where you can invest as little as $5,000 and you aren’t subject to any safekeeping or custody fees. For those of you who want the upside potential of the gold market but don’t want the risk, our Gold MarketSafe CD is the perfect option. We will be closing this month’s MarketSafe CD offerings out next Tuesday, so you will have to hurry if you want to participate.

On the currency side of your asset allocations, I like our Index CDs. The newest index, the WorldEnergy CD is quickly becoming our most popular investment. It combines the currencies of Australia, Canada, Britain, and Norway into a 3 or 6 month CD. The EuroTrax is also popular with its exposure to the Swiss franc (CHF), Norwegian krone (NOK), Swedish krona (SEK), and euro.

Finally, the Commodity Index CD has been a solid performer ever since we first introduced it five years ago. It combines the New Zealand dollar (NZD), Canadian dollar (CAD), Australian dollar (AUD), and the South African Rand (ZAR). But enough of the sales pitch, on to the currency roundup.

Currencies today: A$ .8362, kiwi .7515, C$ .9399, euro 1.3312, sterling 1.9699, Swiss .8029, ISK 62.80, rand 7.1850, krone 6.08, SEK 7.0826, forint 188.99, zloty 2.863, koruna 21.47, yen 123.48, sing 1.5428, HKD 7.8202, INR 40.88, China 7.6250, pesos 10.8687, dollar index 83.09, Silver $13.08, and Gold… $650.33

That’s it for today… The past week has been a real wake up call for everyone on the desk. We go through life at a pretty hectic pace and don’t ever expect anything bad to happen to any of us. But God has a way giving us the occasional reminder of our mortality. This Sunday is the big day for all of us fathers, and Chuck usually writes something about his dad who was a hard working truck driver in South St. Louis. I’m lucky enough to still have my father close by, so I will be stopping by to spend a little time with him Sunday morning. I know Chuck will be spending the day at the hospital, and I’m sure he would rather be at the ballpark no matter how the Cardinals are playing! But he will be surrounded by his loving family; and with his recent troubles, I’m sure this will be one of the most joyous father’s days he has had. I hope everyone has a terrific Friday and a great weekend!!

Chuck Butler — June 15, 2007

The Daily Reckoning