Greenspan Is At It Again

Good day… The dollar broke out of its range overnight and moved higher versus just about all of the currencies. The dollar was helped by some comments by former Fed Chairman Alan Greenspan and expectations that the economic data due to be released will show the U.S. economy has turned the corner.

The former fed head was at it again. Greenspan, speaking at an event in NY, said the historically low yield premiums on emerging market debt, “ain’t going to continue that way. And indeed, all the spreads you are looking at, including mortgage spreads relative to the 10 year, are going to start to open up and the 10 year is going to be moving as well.” His comments were interpreted as a projection of still higher yields in the United States, which caused some currency traders to buy the dollar.

As you will recall, in February his warning of a possible U.S. recession coincided with a worldwide stock-market rout. So the markets still pay attention to the former Fed chief’s views. But what is Greenspan really saying? He is telling us that emerging market debt is currently overpriced, and that inflation will cause U.S. interest rates to have to move up. This is not necessarily a good thing for the U.S. economy or our dollar.

If interest rates do continue to increase, which I believe will happen, mortgage loan defaults will undoubtedly increase. As Chuck has pointed out numerous times, there are a record number of Adjustable Rate Mortgages ready to reset in the next few years. Rising yields will have a dramatic impact on U.S. consumers who are currently spending just about all they make. When you add an increase of a couple hundred dollars to their mortgage, something is going to have to give. The news media have moved this story off the front page, but the subprime mortgage meltdown is still happening. The scenario that is shaping up here in the United States doesn’t give me confidence in the dollar.

Data scheduled to be released this morning will show that retail sales in the United States rose in May, as record gasoline prices lifted purchases at service stations. I don’t think these are the type of retail sales that are positive for the U.S. economy, but the news media will certainly make a big deal about how sales are up in the United States. According to preliminary estimates, most retailers other than filling stations probably suffered as the high gas prices left Americans with little extra cash to spend at the mall.

Later this afternoon we will get the release of the Fed’s Beige book, which is a summary of current economic conditions by the Federal Reserve districts. This report is used as a basis for discussion at the upcoming FOMC meeting, so the markets will be looking for any signals on interest rate moves. I still believe the FOMC will have to sit on the sidelines, as inflation pressures will offset a slowing economy.

We will get additional data releases tomorrow and Friday, so look for an increase in volatility as we move through the end of the week. The markets have set themselves up for positive numbers here in the United States, so right now I believe the risk is that the numbers disappoint, and the dollar gets sold back off. But we will just have to wait and see.

We had a mixed bag of data released in Europe overnight, as French consumer prices stabilized and German business confidence rose, while Europe’s industrial production took an unexpected drop. French annual inflation slowed to 1.2% in May, the lowest since November 1999.

Reports also showed a drop in European industrial output. Production at factories, utilities, and mines in Europe fell 0.8% from March, when it grew a revised 0.5%. Economists had expected a 0.2% increase in April. Offsetting this negative output number was German business confidence, which rose in April and May to the highest level since the country’s re-unification in 1990. Overall the data did nothing to support the euro (EUR), but it won’t change the ECB’s hawkish stance, and I still expect interest rates to continue to rise through the end of the year.

The Swiss central bank will likely raise its benchmark interest rate to a six-year high tomorrow. The Swiss economy has been expanding, and the carry trade has helped keep the value of the Swiss franc down, adding to inflationary pressures. The SNB is predicted to raise the target rate by a quarter point to 2.5%, the highest since September 2001. But this won’t be the last move by the SNB, as they are expected to continue to raise rates over the next two quarters. For now, the Swiss benchmark rate is still the second-lowest among industrialized nations after Japan’s 0.5%, encouraging investors to borrow francs to fund the ‘carry trade’.

As interest rates increase, these investors will start to move out of these short positions and the Swiss franc will move back up. While Japan may continue to keep rates down, the Swiss National Bank will get more aggressive on their interest rate moves. These increases should help the Swiss franc be one of the best performing currencies from now until year-end. Investments in the Swiss franc are an excellent addition to those of you who have speculated on some of the higher yielding currencies such as the Icelandic krona (ISK) or New Zealand dollar (NZD).

As I mentioned above, the BOJ is not expected to make a move on interest rates this week as it awaits more evidence on the strength of the economy after consumer prices fell for a third month. I disagree with the BOJ on this one as the carry trade has kept the currency undervalued, which will ultimately lead to inflation.

The BOJ is playing a dangerous game, knowing that any increase in interest rates could start to cause the carry trade to unwind forcing the yen (JPY) up. They have been more than happy to have investors borrow yen and sell it, keeping the yen undervalued and the price of their exports down. Unfortunately, the longer they wait to increase interest rates the more dramatic the currency move will be.

China’s retail sales unexpectedly accelerated at the fastest pace in three years, buoyed by rising incomes and a stock market bubble. Sales rose 15.9% from a year earlier. So it looks as though China is finally moving closer to a consumer economy. This move will help offset the slowdown in the U.S. economy, and should keep all of the currencies of the countries that are supplying China with raw materials moving up. The Australian dollar (AUD) and the Canadian dollar (CAD) will both continue to benefit from increasing demand in China.

Currencies today: A$ .8375, kiwi .7473, C$ .9337, euro 1.3274, sterling 1.9689, Swiss .8024, ISK 63.76, rand 7.2821, krone 6.1051, SEK 7.0976, forint 191.82, zloty 2.8926, koruna 21.52, yen 122.41, sing 1.5441, HKD 7.8166, INR 40.99, China 7.6325, pesos 10.9988, dollar index 83.23, Silver $12.87, and Gold… $644.65

That’s it for today… Chuck sent me the following message, which he asked me to share with all of his readers today:

“I have to share some bad news with you…

“As you all know I have had a problem with my hip since March, after extensive tests to determine why it wouldn’t heal, they finally found the problem. The muscles are being stretched by a growing tumor.

“Where did this tumor come from? Unfortunately, they found that my left kidney has been taken over with cancer. The kidney cancer sent a seed to my hip.

“Tomorrow, I will have surgery to remove my left kidney. After I heal from that, I will see an oncologist about the tumor on my leg… Most likely they will submit it for radiation to attempt to shrink it… But in the end, they will probably just go in and cut it out.

“The good news is this… This is curable… And the bone scan I had done last week does not show any other ‘hot spots’… So… I will get this all out of me ASAP!

“Please keep me in your thoughts Thursday…”

I have known Chuck for close to 20 years now, and can tell you he and his family are very strong. He has a great attitude about the disease and will undoubtedly beat it. Please keep him in your thoughts and prayers.

Chuck Butler — June 13, 2007

The Daily Reckoning