FOMC Minutes Spook The Markets

Good day. And welcome to June! Well, the FOMC minutes of the May meeting spooked the markets yesterday and everyone ran for the hills to buy dollars. In case you missed the announcement, the minutes first reported that the Fed Heads didn’t know what to do with interest rates at the next (June) meeting. And that was not dollar friendly.

However, that was soon wiped out (and more) when it was reported that the Fed Heads did discuss a 50 BPS rate hike, which led the markets to believe that the Fed was going to go higher with rates. Now, I’m a person that thinks logically. Most of the time the markets defy logic. This is one of those times. However, I learned a lesson long ago. You, me, and the lamppost are not big enough to fight the markets once they have made up their collective minds. What has to happen is that sooner or later – and hopefully sooner – they come to their collective senses and realize what dolts they have been!

Basically, I’m saying that just because 50 BPS was discussed, doesn’t mean it’s going to happen! Shoot, Rudy, just the other day I was discussing the purchase of a Major League Baseball team with my beautiful bride. That doesn’t mean it’s even feasible that it could happen! I’m so tired of this interest-rate talk supporting the dollar that I could just shake a big-time trader until he saw things my way!

So, before I step up on my soapbox and go off on a tangent, I think I’ll get back to the task at hand and talk about the currency performance yesterday. Oh, that’s right, I already told you that traders, investors, and dollar bulls ran to buy dollars, which means that no currency went unscathed! However, the euro did remain above 1.27, which means that in the end, it was just another round of range trading! Yes, these “guys” bought dollars, but in the end, they didn’t have the follow up from other sources to really take the dollar higher. No Sly Stone. No, I wanna take you higher! Ahhh, Woodstock.

All those lofty levels for the currencies that were seen in yesterday’s currency roundup have been lost. Even the Belle of the Ball, the Canadian dollar/loonies saw selling to bring it below the 91-cent handle. The thoughts going around on Monday and Tuesday that the change in U.S. Treasury secretary might be the harbinger to a change in currency policy has been put on the back burner for now. But, I believe there’s more to this story than what the markets are giving credit to. That’s something to keep in our memory banks and pull out when and if it actually happens!

There are some rumors going ’round, someone’s underground, and – No wait! The rumors, going around are that the ECB is starting a whispering campaign to hike rates 50 BPS next week. This hasn’t really taken hold, and I think it best to keep to the plan of 25 BPS in June, September, and December!

However, one has to go back to the days of the Bundesbank (it still exists) and see that they not only used consumer inflation as a key to interest-rate policy, they also used money supply. The increase in loans to consumers and companies has really accelerated lately pushing money supply up over eight percent versus a year ago. So, 50 BPS just might be in the cards when the ECB meets next week. And, hear me now and believe me later: that type of move would really wipe out all this talk about the dollar enjoying a widening interest-rate gap, which would support the euro getting back to 1.30 and higher!

Let’s hope all this back-and-forth, dollar-is-in-dollar-is-out trading that went on during May is over with. Hopefully, June will be busting out all over, all over the meadows and the fields. Even with the back-and-forth sentiment in the dollar, the euro did gain almost two cents in May. But, we had so many Wayne-and-Garth moments of “Game On, Game Off,” that it didn’t really even feel like we had a positive gain at times! As I always tell my audiences, even in a strong trend, there is volatility; there are no “one way” tickets!

A report on European manufacturing just printed and it shows an unexpected acceleration for the month of May! In fact, I’m seeing that European manufacturing hit the highest index level since 2000! The stronger euro hasn’t put the whammy on European manufacturing yet, mostly because of domestic demand. Good stuff for the European Union, eh?

A few weeks ago, I told you of a report from China that an advisor had recommended that China increase their gold reserves. With that, gold shot through the $700 level. Well, the Chinese Central Bank advisor has made the formal recommendation to diversify reserves into gold. Right now, only 1% of the Chinese reserve is held in gold, compared to more than 70% held in either dollar or dollar assets like U.S. Treasuries.

Gold has really seen the sellers, most likely profit takers, lately, and some follow through from this report would go a long way toward lighting a fire under gold again!

Overnight, it was reported that Thailand’s consumer inflation rose to 6.2% in May. The forecast called for a rise to 6%, which in my opinion would be 6% too much to begin with! The Thai Central Bank needs to meet this rise in inflation with a strong rate increase, which I think they will do, but we’ll have to wait-n-see.

The “risk aversion” I’ve been talking about continues to have a grip on currencies like rands, rupees, krona, lira, and pesos. A trader friend sent me a note that he doesn’t expect this risk-aversion trend to be as short lived as previous ones. OK. That means we could continue to see rot on the vine with these currencies. No one knows for sure how long it could last, but at least we should be prepared for the bad wine!

You know, the Eastern European currencies of Poland, the Czech Republic, and Hungary haven’t been tarred with the same brush as the other emerging markets. Does this mean they have reached maturity? Recall in 2002 when I said that these three were on the “fast track” to conversion to the euro? I put them together and called the CD the “European Opportunity.” The interest rate on the CD was a whopping 7.75%! Well, interest rates there are no longer that high, as these three continue to get their ducks in line to become eligible to join the Euro club. I just thought I would bring you up to date on these three.

The data cupboard gives us productivity for the first quarter (long-time readers no that I dislike this report very much!), construction spending, vehicle sales, and the Big Kahuna of the day: ISM manufacturing index for May, which we saw unexpectedly jump last month.

Currencies today: A$ .7480, kiwi .6310, C$ .9050, euro 1.2770, sterling 1.8630, Swiss .8170, ISK 72.30, rand 6.7550, krone 6.10, forint 206.31, zloty 3.09, koruna 22.1640, yen 113, baht 38.25, sing 1.5840, INR 46.30, China 8.0184, pesos 11.3450, dollar index 85.01, silver $12.14, and gold $631.10

That’s it for today. Thanks to Jen and everyone on the desk for covering me; I snuck out to watch the Cardinals play the Astros. There’s something about day baseball games that makes me want to be there. Of course, I’m a big believer that baseball was made to be played during the day! Tomorrow, the big rivalry renews with the Cubs coming to town. I’ll be there! Have a great Thursday and a great June!

Chuck Butler
June 1, 2006

The Daily Reckoning