Durable Goods Fall, But Business Spending is Up

As Chuck informed all of you on Friday, I have got the conn on the Pfennig today and tomorrow as he was called down to Jacksonville for a few meetings. As always, Chuck left me with a few tidbits to get me going, so I’ll kick off today’s missive with Chuck’s view of the markets:

On Friday, the US data printed much softer than expected, and for the first time in a long time, bad data results did not mean a dollar rally! Instead, fundamentals would have the dollar selling off from a Durable Goods Orders print that fell 1.3%, and New Home Sales that were flat… And that’s what happened!

The euro (EUR) added to its gains moving well into the 1.34 handle. And the Aussie dollar (AUD) is now within’ spittin distance of 96-cents!

Speaking of Aussie… The Australian government announced on Friday that their deficit had narrowed, and that they were sticking to their forecasts for a return to budget surpluses in 2011… Ahhh… How sweet that would be!

A narrowing budget deficit – which by the way is only $54.8 billion, a HUGE positive yield differential, and a not collapsing China – has the Aussie dollar on the rally tracks, and now there’s another broker (BNP) that’s calling for the Aussie dollar to reach parity to the US dollar in 2011… Again, take these broker calls with a grain of salt… But you do now have two large brokers that say their research teams believe the Aussie dollar will hit parity in 2011…

And gold and silver were not able to push past the levels they traded at on Friday morning at the time the Pfennig was sent out. But don’t despair… And while you can’t say that anything ever moves in one direction, I truly believe gold and silver to be positioned to move higher… Of course, that doesn’t rule out that they could very well move lower first!

Thanks to Chuck for getting us kicked off this morning. As he pointed out, the US Durable Goods orders were softer than expected, but in direct contradiction to what would be expected with the weaker data, the US stock market moved higher and the dollar slipped lower. So what happened? Let me explain. The Durable Goods orders are broken up into two different series: one with transportation and one without. This is done to smooth the volatility, which large orders in the aerospace industry bring to the overall number. In July, Boeing booked 130 orders for planes, but only booked 10 orders in August. This helped contribute to a 10% drop in transportation orders and moved the overall index down 1.3%, but the number ex-transportation actually climbed 2% in the same period. This was double what economists expected, and had the stock jockeys dancing in the streets.

The jump was mainly due to increased spending for US business equipment including computers and phone gear. Spending by businesses to replace outdated equipment could keep the US economic recovery going in spite of the reluctance of the US consumer. This positive spin on the durable goods number took the stock market higher and the dollar lower, which is more along the lines of what we have come to expect. As long as the US economy can limp along, the global recovery will continue and the dollar will get sold on poor fundamentals. The only hope for those predicting another dollar rally is poor economic data, which would generate another round of “safe haven” buying for the greenback.

As confidence in the global economic recovery rises, investors are turning back to the carry trade. But the funding currency is no longer the Japanese yen (JPY) or Swiss franc (CHF), it is the US dollar. Last week’s announcement that the FOMC would keep rates low for an “extended” period has convinced investors to borrow dollars and sell them to invest the proceeds into higher yielding currencies. The recent strength of the Swiss franc and Japanese yen have caused investors to turn away from them for funding these leveraged trades. Positioning data point to growing US dollar short positions, with investors moving funds into the high yielding commodity currencies. The carry trade can have a huge influence on the currency markets, and now that the US dollar is the funding currency of choice, further dollar weakness is inevitable.

The return of the carry trade helped push the Australian dollar over 0.96 and near a two-year high versus the US dollar. The Aussie has been the second best performer this year and as Chuck pointed out earlier, many are now predicting it will hit parity before the end of the year. Economic fundamentals certainly seem to support a $1 Aussie! The RBA will make a rate announcement next week, and many are now looking for a quarter point increase. A move higher by Aussie’s central bank could be just the thing the Aussie dollar needs to push through parity with the US dollar.

The euro has held stable over the weekend in spite of warnings about the government’s bailout of Anglo Irish Bank. The announcement later this week regarding the predicted costs of the bailout has focused the currency market’s attention back on the state of the European Union. Der Spiegel sent a shot across the bow of the euro when it reported that the European Commission lacks confidence in the viability of German regional lenders. We have warned readers that the European debt problem isn’t over yet, and this story has refocused investors’ attention onto the negative structural issues in Europe.

But the euro has shook off all of these worries and climbed all the way to $1.3506 this morning. This is the first time the euro has moved above $1.35 handle since April. I read several research reports over the weekend that are warning investors of this quick climb by the euro. Chuck pointed out last week that the euro gapped from $1.31 to $1.34 in just two days, so there certainly seems to be the basis for a short-term pull back to “fill these gaps.”

We are also seeing a bit of verbal intervention by some of the banking leaders in Europe. Europe’s largest economy, Germany, is dependent on exports, and the recent euro strength could threaten the export-led recovery. European leaders have begun to try and jawbone the markets, letting them know there are still some questions regarding the health of their financial system. These recent warnings definitely smack of a bit of verbal intervention in order to try and slow the pace of the euro appreciation.

A quick look at the economic calendar for the rest of the week tells me we should have a quiet start to the week. Today we will see some regional fed reports, and tomorrow we will get another look at the US housing market with the release of the S&P/CaseShiller numbers. We will also see September’s consumer confidence numbers, which are predicted to have slipped a bit. Wednesday is a “no data” day, but Thursday and Friday will make up for it as they are chock full of economic reports including GDP, personal income and spending, construction spending, vehicle sales, ISM Manufacturing index, Core PCE, and the weekly jobs numbers. Should make for an exciting end to the week.

To recap… US durable goods data on Friday were down, but after transportation orders were removed, the data showed that business spending actually increased. The good vibes in the US markets caused investors to take on more risk, selling the US dollar as the funding currency of the carry trade. The Australian dollar continued to rally toward parity, and the euro held stable in spite of bank warnings.

Chris Gaffney
for The Daily Reckoning

The Daily Reckoning