FOMC Finally Comes Clean (Sort Of)

Good day… Chuck heads out of town today, back down to sunny Florida for another speaking session on the benefits of diversification. Luckily he is flying on Southwest, as I heard American Airlines has been canceling flights for more inspections. But I guess you can’t complain when your flight is canceled or delayed so they can make sure your plane is safe to fly. Safety was the buzzword in the currency markets again yesterday as the higher yielding currencies were sold again in favor of the strong and stable economies.

The best performing currencies yesterday were the Norwegian krone (NOK) and Swedish krona (SEK) both of which enjoy strong economies and central banks who have their eye on inflation. Chuck predicted that these two currencies would continue to have a good year in 2008 as investors searched out those economies that had the best underlying economic fundamentals. These Nordic economies fit the bill and continue to attract investors.

Unfortunately, I don’t think anyone would use ‘strong and stable’ to describe the U.S. economy right now. Even the FOMC seems to have finally come to the realization that we are in a recession! Yes, the minutes of the last FOMC meeting were released yesterday afternoon, and they showed the Federal Reserve officials are now anticipating that the economy would shrink in the first half of the year. Some were even concerned about “a prolonged and severe economic downturn.” Finally!! I guess they are just a little slow on the uptake; they had to wait until the data hit them like a 2 x 4 upside their heads.

Policy members said they saw little sign that housing markets have reached a bottom and ‘some believed that a prolonged and severe economic downturn could not be ruled out’ according to the minutes. Even Big Ben had to admit last week that the U.S. economic expansion is coming to an end. So now, over a full year after Chuck warned of the coming downturn, the Fed agrees that we are in a recession. I guess sometime next year, when inflation hits double digits, we will hear them start worrying about rising prices.

The results of a survey by Bloomberg news showed that economists now predict that the U.S. economy will not expand at all from January through June of 2008. A majority of these economists actually predict that the United States is now, or will soon be, in a recession. We believe we have been in a recession since the beginning of the year, and we’ve got more than a few more months before we get clear of the downturn. Meanwhile, the dollar will continue to slide versus the currencies of those economies that are more stable.

The United Kingdom seems to be moving in a similar direction as the United States, as a housing crisis continues to drag down their economy. Both the U.S. and U.K. released data yesterday that showed a continued slump in their respective housing markets. The National Association of REALTORS’ index of homes under contract decreased 1.9%, to the lowest reading since records began in 2001. U.K. house prices in March dropped by the most since 1992 according to a report released in London. Another report showed that U.K. consumer confidence slid to the lowest level in almost four years. These reports caused the pound (GBP) to continue to sell off versus the euro (EUR) and U.S. dollar, as investors are predicting a cut by the BOE at their meeting tomorrow.

While an interest rate cut by the BOE is likely, the ECB will leave their rates unchanged tomorrow. The European economy has been able to continue to grow in spite of the stronger euro and higher inflation. German exports were unchanged in February, after rising 3.6% in January. Business confidence in Germany rose last month and manufacturing growth accelerated, suggesting that Europe’s largest economy is weathering the slowdown in the United States. February unemployment fell to the lowest level since August 1992, while industrial output increased. With a strong economy and oil continuing to hold above $100 a barrel, the ECB will have to keep interest rates unchanged at their meeting tomorrow.

The Bank of Japan kept interest rates on hold at the first meeting chaired by Masaaki Shirakawa, the newly appointed governor. They also cut their assessment of the economy for the first time in four months amid concerns that a recession may be looming. High energy costs and raw material prices are likely to continue to put negative pressure on Japan’s economic growth according to the central bank’s monthly report. But recent economic data have been mixed, as export growth and inflation accelerate while production and corporate sentiment fall.

But even without an interest rate increase, the Japanese yen (JPY) looks to continue to increase, as investors reduce leverage in an increasingly volatile market. A reversal of these highly leveraged carry trades will move the Japanese yen through 100 yen/US$. Any future increase by the BOJ will just accelerate this yen appreciation.

The Australian and New Zealand economies have proven to be resilient enough to withstand a U.S. economic slowdown, as both currencies continue to appreciate versus the U.S. dollar. Australia’s dollar (AUD) gained for a sixth day versus the U.S. dollar after a newspaper reported that China is looking to buy a stake in a major Australian based mining operation. Reports will likely show that Australian employment rose for a record 17th month as mines have boosted hiring to meet Chinese demand for resources. New Zealand’s dollar (NZD) also rose for a third day after Reserve Bank of New Zealand Governor Alan Bollard said the economy remains fundamentally sound.

These two currencies have been steady performers because of their wealth of natural resources. Demand in China and India doesn’t seem to be slowing, so commodity prices will continue to support these currencies. As our friend, Jimmy Rogers continues to preach, the commodity boom is not yet over. The growth in Asia will continue to help support the currencies of those countries that are providing the Asian economies with the raw materials needed for this economic growth.

One commodity that didn’t rally yesterday was gold, which dropped for a second consecutive day in London. Declines in Asian and European stock markets spurred investors to sell bullion in order to meet cash calls. The credit crisis has many investors searching for liquidity to meet margin requirements. Most have profits in their precious metal holdings, and these are easily sold to generate much needed cash. We continue to view these liquidity driven drops in the price of precious metals as a good time to purchase, and not a sign that the long-term commodity boom is reaching an end.

Currencies today 4/9/08: A$ .9300, kiwi .7968, C$ .9829, euro 1.5720, sterling 1.9716, Swiss .9861, ISK 71.76, rand 7.8279, krone 5.0528, SEK 5.9563, forint 161.20, zloty 2.1973, koruna 16.00, yen 102.64, baht 31.76, sing 1.3808, HKD 7.7903, INR 40.025, China 7.0017, pesos 10.5585, BRL 1.6947, dollar index 72.274, Oil $108.22, Silver $17.45, and Gold… $904.28

That’s it for today… More rain here in St. Louis today as we continue with our one day of sun versus two days of rain pattern. How about that start by the Cardinals? They had another big win last night over the Houston Astros. And finally, congrats to the Lady Vols who won another NCAA championship. Hope everyone has a Wonderful Wednesday!!

Chris Gaffney
April 9, 2008

The Daily Reckoning