Fed revisions

Good day…Friday was a quiet day in the currency markets – the dollar trending up a bit. With no data due out this morning, I don’t expect today to be much different. The markets will be setting themselves up for the FOMC rate decision, which is expected on Wednesday. We expect the Fed to keep rates steady, but will be interested in seeing just how worried they are about inflation risks.

A story regarding revisions made by the Fed’s number crunchers circulated through the news services over the weekend. It seems the Fed’s staff threw out previous conclusions about how fast the economy can grow without fueling inflation. They concluded that the speed limit is lower than previously thought…and they lowered it still further in the ‘Greenbook’ for the September policy meeting. The implications: Unless the economy slows more than the Fed now expects, the central bank may have to resume raising interest rates sooner rather than later to control inflation.

Currency traders are using this story to strengthen the dollar prior to Wednesday’s FOMC release. But this dollar strength may quickly evaporate prior to the FOMC rate decision as we will see the MBA mortgage applications data and existing home sales data released Wednesday morning. According to traders of mortgage-backed securities, delinquencies and foreclosures are set to increase dramatically at a time when the number of homes for sale as measured by the National Association of Realtors, is at a 13-year high. The percentage of home-loan payments more than 60 days delinquent rose to 7.23 % in July from 5.9 % a year earlier, the fastest rate of increase since 1998. A sharper than expected slowdown in the housing market would have to weigh heavily on future FOMC rate decisions. For now, I believe the Fed will keep rates stable well into 2007 as the U.S. economy continues to cool and inflation remains subdued.

Friday’s weakness in the Euro may be reversed today as the Bundesbank said the German economy expanded at a ‘good pace’ in the 3rd quarter. Germany’s economy is headed for the fastest expansion since 2000, as companies boost spending and hiring, bolstering consumer optimism. ECB member Nout Wellink, said Friday that interest rates in the euro region are ‘very low’ and the speed of economic growth risks fueling inflation, suggesting he supports further rate increases next year. ECB President Jean-Claude Trichet has signaled that the bank is poised to raise borrowing costs for the sixth time in 12 months in December to keep inflation in check amid the fastest economic expansion in six years. With a strong economy and a narrowing interest rate gap versus the United States, the Euro should trade back above 1.30 by year’s end, and up to 1.40 during 2007.

The commodity currencies have been coming back, which has supported one of our favorite currencies, the Australian dollar. While Australian inflation has slowed recently, the central bank is still expected to raise interest rates next month. While the New Zealand dollar has been the star of the commodity currencies recently, we expect the central bank to leave the benchmark interest rate steady at next week’s meeting. The Australian dollar will likely strengthen versus the kiwi, and continues to be our ‘pick’ of the commodity currencies.

Ty Keough pointed out a story that appeared in Friday’s ‘Daily Wealth’ written by Dr. Steve Sjuggerud, who was speaking about the legendary Jim Rogers. Dr. Sjuggerud wrote as follows:

“Whenever Jim speaks, he invariably reminds the audience that there’s just no new great commodity supplies out there. That no major oil fields have been discovered in more than 35 years. And no major new metal-mine shafts have been sunk in 20 years.

While we don’t have the supply right now, demand continues, whether it’s Americans guzzling gas or the Chinese consuming raw materials to grow (China is now the world’s No. 1 consumer of copper, steel, and iron ore, and the No. 2 user of oil).

Rogers reminds us that there will be nasty corrections, like gold’s correction from $200 to $100 an ounce in the mid-1970s. Although it’s extremely hard to pull the trigger during those corrections, Rogers sees them as buying opportunities.

And here’s what may be my favorite Jim Rogers theory on the commodity bull market: ‘The commodity boom, like all bull markets, eventually will end in a crescendo of hysteria. The public will feel an overwhelming desire to invest in raw materials rather than stocks or bonds.’

We are a long way from there yet. Jim Rogers – and I – think we have about decade to go.

By 2016, we hope to be selling our commodities close to the top.”

Obviously Dr. Sjuggerud still thinks we have some room left in the commodity markets and that these markets will be supported by growth in the Asian region. We agree with both of these statements and continue to suggest investments in the Australian dollar and Orient Opportunity Index CD.

Finally, the Chinese renminbi strengthened again, based on speculation that China’s economy will maintain growth that will keep attracting investors bet on a stronger currency. China will sustain growth of around 10% according to economists at JP Morgan and Deutsche Bank. The strength of the Chinese economy will continue to put pressure on the renminbi to appreciate.

Currencies today: A$ .7580, kiwi .6646, C$ .8867, euro 1.2556, sterling 1.8736, Swiss .7896, ISK 68.86, rand 7.6769, krone 6.7118, SEK 7.3365, forint 209.74, zloty 3.08, koruna 22.58, yen 119.21, baht 37.26, sing 1.5766, INR 45.38, China 7.8985, pesos 10.86, dollar index 86.72, Silver $11.69, and Gold… $588.00

Chris Gaffney
October 23, 2006

The Daily Reckoning