Fighting Inflation

Good day… And a Marvelous Monday to you! I hope you had a grand Father’s Day. Mine was fabulous! And a great weather day too! Cards take 2 of 3 from the Phillies after getting royally spanked on Friday night! UGH! And I got to see my first ever Polo game on Saturday! I’ve seen 100’s of water polo games, as son Andrew was a good player in High School, but never a Polo game on horses… Absolutely cool!

OK… Friday was not a good day in the currencies as once again the dollar took the hammer and swung a mighty swing. The euro (EUR) spent the day in the 1.53 handle, as more and more talk about the Fed fighting inflation took hold of the markets. I’m still resisting this rhetoric by the Fed, and believe that eventually the markets will come to the realization that the Fed is simply “talking the talk” and are unwilling to “walk the walk”.

Think of what 75 BPS (which is what some are saying the Fed will hike rates this year) would do for the economy… Or… Think about what it would do the melting mortgage sector… Or… Think about our deficit, and the bonds we have to issue; what does 75 BPS do to the future interest payments on those bonds? None of these are good outcomes. Yes, I believe the Fed needed to do something a long time ago to deal with inflation, but they turned their back on us and inflation… Now, suddenly they are “inflation fighters”. That’s like a fireman watching a house burn almost to the ground before attempting to put it out… It doesn’t make any sense to me.

But, that’s what the market is all about these days… The Fed and higher interest rates, thus taking away the positive interest rate differential of the euro and other currencies.

On Friday, Ireland voted “no” to a treaty that would create the post of full-time president with the goal of upgrading Europe’s role in world affairs. Once again, just as in 2005 when France voted “no” on a Eurozone referendum, the euro naysayers came out of the woodwork. Eighteen countries have already passed this treaty, leaving Ireland as the only “no” vote so far. I don’t know where this takes the Eurozone and the euro, but I can only think that this is nothing more than a tempest in a teacup.

Friday also saw the stupid CPI (consumer inflation) data for May, in which, the monthly number jumped form 0.2% to 0.6%, and the annual number to 4.2% from 3.9%. The core number, which takes out food and energy – which is totally useless in times like this – showed that the annual rate remained at 2.3%. So… Normally, the media only highlights the “core” number… But when it plays well with what the markets are thinking, the media switched gears and reported the “overall” number – which is fine with me, but why change horses in the middle of the stream?

The U. of Michigan Consumer Confidence Index fell further in the first two weeks of June, from 59.8 to 56.7. Just to give you an idea of how far this index has fallen… The index averaged 85.6 in 2007… And the index of consumer expectations for six months from now, fell to 49 from 51.1. So current feelings are not great and neither are futures expectations… And the Fed is going to raise rates?

Today, we’ll see the latest TIC Flows data… This is the report that shows the net security purchases in the United States. As I’ve reported many times in the past, this report gives us an indication of whether or not foreigners are buying enough U.S. assets to finance the current account deficit – which, by the way, will be printed tomorrow. I’m going to say that the TIC Flows will show that the deficit was not financed appropriately in May. We’ll see later this morning.

Right now, I’m seeing the euro rally a bit on news that inflation in the Eurozone reached 3.7% in May, which was more than forecast (3.6%). This is the highest level of inflation in the Eurozone since June 1992… Which was about the time I moved over to trade foreign bonds at the old Mark Twain Bank. That’s a long time ago! The reason the euro is rallying on this news is simple… The European Central Bank (ECB) all but told the markets they would raise rates at their July meeting, and this data all but puts those rate hike thoughts down as a “done deal”.

I personally don’t like to see inflation that high, but I believe the ECB has done a good job of recognizing inflation, and reacted accordingly months ago, while the Fed was concerning themselves with being a “White Knight”.

The Japanese yen (JPY) continues to get dragged through the mud of the carry trade, which is really the cat’s meow in the markets again. Risk is no longer a threat to the markets (as they see it) and that’s a whole line of consecutive green lights for the risk takers. I feel bad about this move, because I truly believed that this “risk taking” was going to be a thing of the past in 2008. It still may be, but we’re almost half-way through the year now… UGH!

In Australia, the economic data last week tended to be softer… But inflation was higher. I think this keeps the Reserve Bank of Australia (RBA) at the rate hike table, which should continue to underpin the Aussie dollar (AUD).

Across the Tasman, New Zealand posted a nice gain in retail sales in April of 1%, nearly reversing the -1.2% drop in March. It is believed that the sharp fall in March, and the near reversal in April was all due to the timing of the Easter Holiday, which led to less buying days in March than April. It just goes to show you just how small the New Zealand economy really is. Again, I believe that the Reserve Bank of New Zealand (RBNZ) is finished with their rate hike cycle. That doesn’t mean they will begin a rate cutting cycle right away… It just means rates probably aren’t going any higher here… But they should be in Australia, which is one of the reasons I like Australia over New Zealand.

We also had a G-8 meeting this weekend. Yes, I know, it probably slipped right by you! I had forgotten all about it until I turned on the screens this morning. The formal communiqué after the meeting made no mention of the dollar or exchange rates. There had been some thought in the markets that G-8 would “pile on” the “pro dollar” talk… But they did not… And that has caused some selling of dollars this morning.

The G-8 ministers did focus on rising inflation… And one thing I did hear this weekend was this little snippet… The Chairman of Nestle has declared that high food prices “are here to stay” as governments divert resources to make biofuels, amass stockpiles and limit exports. Doesn’t that make you feel good about going to the grocery store this week?

More Fed Speak is on the docket this week, with Big Ben, Lacker, Kohn, and Yellen all scheduled to speak.

Saudi Arabia announced over the weekend that they would increase oil production from 9.45 million barrels per day to 9.50 million per day. But oil prices are still around $135.

The Swiss National Bank (SNB) will meet this week, and while I think they should raise rates, it is widely expected that they will keep rates unchanged. A rate hike here would really make using the Swiss franc (CHF) as a funding currency of the carry trade an expensive proposition.

Currencies today 6/16/08: A$ .9405, kiwi .7635, C$ .9740, euro 1.5465, sterling 1.9635, Swiss .9585, ISK 79, rand 8.0850, krone 5.1860, SEK 6.05, forint 159.70, zloty 2.19, koruna 15.6440, yen 108.25, baht 33.25, sing 1.3745, HKD 7.8125, INR 42.94, China 6.90, pesos 10.34, BRL 1.6360, dollar index 73.67, Oil $135.50, Silver $16.70, and Gold… $878.77

That’s it for today… The weekend began with some sad news about the passing of Tim Russert, only 58… What a great person he seemed to be to me from afar… I read his book about his dad and growing up a couple of years ago… A good book! The weekend got better starting Saturday though. So, was your Father’s Day great? I truly hope so! This should be an interesting week with a ton of data, and talkers. So stay tuned, same bat time, same bat channel! I hope you have a Marvelous Monday and a Wonderful Week!

Chuck Butler
June 16, 2008

The Daily Reckoning