Finally Some Good News for the U.S. (Sort Of)

Good day… The dollar finally got a little love yesterday as the GDP numbers came in slightly better than expected. The nation’s economy grew at a 2.5% annual pace in the final three months of 2006, a little better than the previous estimate of 2.2%.

But after analyzing the data, it was discovered that the higher growth figure was mainly due to an increase in inventories, which put a damper on the dollar party. A build up of inventories just puts more downward pressure on this quarter’s growth estimates, which are already expected to drop to near 1%. For all of 2006, the economy grew 3.3%, nearly the same as the 3.2% growth in 2005.

In a separate report, the Labor Department reported that initial jobless claims fell by 10,000 last week to 308K, an indication that the labor markets remain tight. Another report yesterday showed that quarterly corporate profits declined for the first time in five quarters. It seems I have been in the right business during the past quarter, as profits for financial corporations (EverBank included) rose $20.5 billion, while nonfinancial corporate profits fell $62.6 billion.

Given the weak growth prospects for 2007, I would expect profits to continue to fall. With less profits, corporations will have less to put into capital spending which will have a further drag on our economy. As readers will recall, former Fed Chairman Alan Greenspan, citing concern about slowing profit margins, said earlier this month there’s a “one-third probability” of a recession this year and the current expansion won’t have the staying power of its decade long predecessor.

Today is a big data day in the United States, as we will get reports on inflation, consumer confidence, and spending. This data will be closely watched, since it will provide indications on the outlook for the FOMC’s interest rate decision next month.

Personal spending is expected to have risen in February at the slowest rate in four months. The report will also show that the Fed’s preferred price gauge (the PCE) stayed elevated, giving policy makers less room to maneuver on rates as growth slows.

As I have said several times this week, the Fed has backed itself into a very difficult position. So far, Bernanke has continued to indicate monetary is still aimed at combating inflation even as risks to economic expansion are increasing. This will be Bernanke’s first big credibility test, as he will have to try and stay the course and keep rates high to combat inflation in spite of several forces that look to possibly push the economy toward recession.

There are signs the housing market problems are spilling over into investments and consumer confidence, but the Fed isn’t willing to accept that yet. Just yesterday, outspoken Fed hawk Jeffery Lacker stated this when asked about subprime mortgage problems: “I don’t see it as a big risk to growth for housing.”

As you all know by now, I disagree with the Richmond Fed President and still look for the subprime meltdown to continue to have an impact on the entire housing bubble. I understand the Fed is looking to maintain credibility by keeping their eye squarely on inflation, and they should. But, I also believe our economy has started down a slippery slope putting the FOMC in a very difficult position.

One central bank that doesn’t have to worry about credibility is the ECB, which continues to steer the European economy on a slow growth low inflation path. Confidence in the European economy unexpectedly rose to a six-year high, and unemployment fell to a record low, giving the ECB scope to raise interest rates further in the 13 nation euro region.

The euro region’s economy, which expanded at the fastest pace since the start of the decade in 2006, will likely continue to gather momentum as companies increase investment spending and hiring, bolstering consumer confidence. As my associate Ty Keough suggested to me yesterday, it finally looks like the former soviet bloc countries are beginning to contribute to the growth in the region; instead of just being a drag on the western economies. The expanded trade relationships have somewhat insulated the euro region from an economic slowdown in the United States. An expanding middle class and more consumerism in China and India will also help keep the world’s economy going.

Crude oil futures climbed past $66 a barrel Thursday, as traders worried about increased tension between Iran and the United Kingdom. The higher oil prices have helped the Canadian dollar, which has been taking a beating since mid 2006. Commodities, such as crude oil and natural gas account for 54% of Canada’s exports.

Another economy benefiting from a jump in oil prices is the Norway, where the krone has out performed all but the Icelandic krona for the first quarter of 2007. (It is actually tied with our other favorite the Aussie dollar.)

Sweden’s central bank left its benchmark interest rate unchanged at the highest in almost four years and reiterated a forecast that it will only increase rates once more this year as inflation remains moderate. The economic fundamentals of Sweden continue to make it an excellent choice for investors looking for a solid currency to purchase for diversification. As I mentioned earlier this week, both Norwegian and Swedish currencies are part of our Euro Trax Index, which has become one of our most popular investment alternatives.

Japan’s fiscal year ends today which typically brings repatriation of funds back home by investors, which could give the yen some much needed strength. Export growth in Asia is showing signs of a pick-up after sliding in the second half of 2006, and rising money supply points to a stronger local demand. Japan’s household spending, as reported last night, rose at double the pace forecast by analysts last month and industrial production fell less than expected.

A separate report showed that the jobless rate held at an eight year low of 4% for a fourth month, suggesting companies are confident enough to keep hiring. With oil prices moving higher, inflation in Asia is likely to drift higher in the latter part of 2007. Interest rates will be raised by the BOJ in the very near future, giving additional support to the yen.

Currencies today: A$.8070, kiwi .7122, C$ .8668, euro 1.3311, sterling 1.9587, Swiss .8195, ISK 65.84, rand 7.2995, krone 6.0984, SEK 7.0262, forint 186.05, zloty 2.9060, koruna 21.03, yen 118.07, baht 32.33, sing 1.5173, HKD 7.8145, INR 43.52, China 7.7342, pesos 11.0221, dollar index 83.21, Silver $13.345, and Gold $663.45

That’s it for today…Busy day yesterday and will probably be again today as we have a few people off the desk. Opening weekend for the World Champion St. Louis Cardinals, so the town will be partying all weekend. I still have a team left in the final four (go UCLA) so I’ll be watching some basketball games in between the baseball. Looks like it will be a great weekend here in St. Louis. Hope everyone has a great one. GO CARDS!!

Chuck Butler — March 30, 2007

The Daily Reckoning