FOMC Watch

Good day. The currency markets were range bound yesterday as their focus was on today’s FOMC meeting. The Fed boys will announce the results of their meeting at approximately 2:15 p.m. EST. The last few weeks’ worth of data from the United States certainly makes it look like a pause is in the cards. The markets will focus, as always, on the accompanying statement, which they hope will signal the Fed’s intentions. I think the FOMC will decide to pause and the statement won’t shed much light on the future of rates here in the United States. The FOMC will again state that they will be watching the data to see whether further tightening is needed. Since a pause has already been priced into these markets, a pause followed by a very hawkish statement or an increase by 0.25%, could give the U.S. dollar support.

We will get some data from the United States prior to the FOMC rate decision. Non-farm productivity and unit labor costs will be released this morning. Productivity is expected to show a dramatic slowdown to 0.8% from last quarter’s 3.7%. Unit labor costs are expected to show a rise to 3.7% from last quarter’s increase of 1.6%. Rising labor costs are one of the factors that could push the FOMC to raise one more time, but the drop in Non-farm productivity shows the U.S. economy is slowing. Bernanke has he expects the economic slowdown to keep wage inflation in check.

Data released yesterday shows that the U.S. consumer continues to leverage the future for spending today. Consumer credit in the United States unexpectedly rose $10.3 billion in June, as Americans used credit cards to finance more of their purchases. The total non-mortgage loans to individuals rose to $2.19 trillion following a revised $5.89 billion increase in May. The two-month gain was the biggest since September/October 2004.  Unfortunately, I think this increase in credit-card debt is a last gasp by consumers sinking under the burden of higher oil prices and the shut down of their “home equity ATMs.”  What will happen once they have exhausted their credit limits on these cards?

Speaking about higher oil prices, I failed to mention BP’s decision to shut down half the production on Alaska’s North Slope. This will reduce the U.S. domestic production of oil by eight percent, or about 2.6% of the United States’ supply including imports. BP is now saying production could be shut down for a number of months, as the several miles of the pipeline will need to be replaced or strengthened. Oil prices will undoubtedly increase because of this supply reduction, causing additional inflationary pressures. This increase in fuel price comes at a very bad time, as consumers are already stretched. While higher oil prices will hurt the U.S. economy, they could actually provide some support to the U.S. dollar since oil is still priced in dollars.

Higher oil prices will certainly help those countries with large exports of crude. Both the Norwegian krone and the British pound sterling have been performing nicely this year, and look to continue their rally. The United Kingdom’s economy expanded 0.8% in the three months through July, exceeding the 0.6% in the previous quarter. The Bank of England will release its latest inflation forecasts tomorrow, which will probably give even more support to the sterling. Britain’s housing market is heating up again with the average price of a house in England and Wales reaching a record in the second quarter according to a report released today. This data supports the BOE’s surprise decision to raise rates last week, and may send the pound sterling up to the $2.00 level by year’s end.

Moving to the Asian markets, the Singapore dollar continues to perform well as the economy grows. Singapore raised its growth forecast for the third time this year after the economy expanded 9.4% in the first half. Prime Minister Lee Hsien Loong said, “After the past few years upgrading and restructuring our economy, Singapore is in a much stronger position than before. Our strategies are working, and our economy is growing and creating jobs.” The Singapore dollar is combined with the Thai baht, Japanese yen, and the Hong Kong dollar in our new Orient Opportunity Index CD. This is an excellent way to take advantage of these currencies while earning a decent interest rate (3.8% APY for three months).

Currencies today: A$ .7604, kiwi .6255, C$ .8938, euro 1.2846, sterling 1.9057, Swiss .8163, ISK 71.0, rand 6.8012, krone 6.1565, SEK 7.15, forint 210.57, zloty 3.013, koruna 21.99, yen 115.05, baht 37.69, sing 1.5739, INR 46.54, China 7.97, pesos 10.88, dollar index 84.76, silver $12.10, and gold $643.03

That’s it for today. We will all wait for the FOMC announcement this afternoon. Since a pause is already priced in, we could see some dollar strength following the report.  Should make for an exciting afternoon! Hope everyone has a great Tuesday!!

Chris Gaffney
August 8, 2006

The Daily Reckoning