Housing Continues to Slow

Good day… The first day of what will be a very busy week saw the housing data come in as expected. Existing home sales dropped 0.3% during the month of May, to 5.99M, the lowest level since June 2003. Inventory of homes for sale rose 5% to 4.43M, which is 8.9 months of supply – the highest level since June 1992. More importantly, prices dropped another 2.1% year on year, which doesn’t bode well for homeowners who need to refinance. The data released today will be more bad news for the housing markets. New home sales are expected to be down 6% after last month’s surprising 16.2% gain. As Chuck pointed out in May, last month’s data was just a one hit wonder and now the markets can move back into the realistic assumption that the housing slump will last into next year.

The Fed policy makers continue to be more sanguine on the outlook for housing and the economy. Fed Chairman Ben S. Bernanke said earlier this month that restrictions on the availability of mortgage credit will slow housing demand. At the same time, he and other officials have said the slump hasn’t spilled over into other parts of the economy. Tell that to Bear Stearns or its investors! As recent losses at the big investments houses prove, the housing slump is going to have very far-reaching tentacles. Housing has supported our economy during the go-go days of the last 10 years, so the downturn is going to have widespread consequences.

In addition to the new home sales, we will see consumer confidence numbers, which are expected to show a drop from last month’s data. So another day of negative U.S. data will put additional selling pressure on the dollar. According to technical analysis, the euro (EUR) may rise to $1.3520 against the dollar, should it close above so-called resistance at $1.3470 on a daily basis. Apparently, resistance at the $1.3470 represents a 50% retrenchment of the euro’s decline to a June 13 low of $1.3264 from an April 27 high of $1.3681, according to a series of numbers known as the Fibonacci sequence. As longer term readers know, this technical data is lost on us, as we more closely monitor the fundamentals. But technical analysis is used by many traders, so I thought I would share this with you.

The big news out of London yesterday was Tony Blair’s handing over of Labor Party leadership to Gordon Brown. Tomorrow both men will make separate visits to Queen Elizabeth II, Mr. Blair to quit as prime minister and Mr. Brown to take over. The currency markets are comfortable with the appointment of Mr. Brown, who was the Chancellor of the Exchequer and oversaw years of economic growth in England. The pound sterling (GBP) rose through the $2.00 mark for the first time since May 2 yesterday, and is expected to hold above this level throughout the trading day.

The pound advanced before a report this week that will probably show that house prices gained for a 14th month in June. Markets now expect the BOE to follow the desires of Governor Mervyn King and get more aggressive on rate increases going forward. These higher interest rate expectations in the United Kingdom, coupled with a weak dollar story, will see the pound sustained above the $2 level. I expect the BOE to hike rates in July with another hike later this year. Aggressive rate hikes by the BOE could push the pound sterling up above $2.05 by year-end.

The International Monetary Fund will raise its forecast for world economic growth this year and said inflation may accelerate as a result. “Global growth is stronger than we had expected in April,” Simon Johnson, the IMF’s economic counselor and director of research, to reporters in Frankfurt today. “Inflationary pressures are definitely building up.” This supports our view that global growth will continue to push interest rates higher. These higher rates will eat into the interest rate differential, which has been supporting the U.S. dollar. The FOMC is not going to be able to move rates up to combat inflation due to the slowdown in housing. As rates move up in Europe and Asia, investors will be selling dollar assets and moving them back into Europe or Asia. More negative news for the dollar!

The Swiss franc (CHF) has become one of our favorite currencies as of late, and for good reasons. Swiss economy minister Doris Leuthard said economic growth may exceed the government’s forecast this year as global demand fuels exports. Swiss companies are boosting spending and hiring to meet orders driven by the strongest world expansion since the 1970s. Swiss National Bank President Jean-Pierre Roth on June 14 said the economy is in “excellent shape” and signaled that the bank is ready to raise its key rate further from 2.5%. Higher rates in Switzerland will continue to pressure carry trade investors who have borrowed francs to reverse their positions and repurchase these borrowed francs in order to pay off the loans. The Swiss franc continues to be one of the “value plays” of the currency market and we feel will end up being one of the best performers of the second half of 2007.

The other funding currency of the carry trade, the Japanese yen (JPY), also gained yesterday. The yen is expected to extend gains from a record low as a report tomorrow is forecast to show that Japanese retail sales accelerated last month, fueling speculation that the BOJ might boost borrowing costs. An increase in market volatility has forced some investors to pare the carry trades. If the data due out of Japan later this week shows that the economy is heating up, the yen should see even more buying and could finally trade back below 120.

In other news out of Asia, Singapore’s industrial production in May expanded more than any economist expected. Manufacturing, which accounts for a quarter of the $134 billion economy, surged 17.7% from a year earlier after a revised 19.6% gain in April. This data illustrates just how “hot” the Asian markets continue to be. While China continues to look for ways to slow their growth, this region continues to be the economic engine for the rest of the world. These high growth rates will continue to keep demand for raw materials soaring which is good news for the commodity currencies of Canada and Australia.

Currencies today: A$ .8496, kiwi .7683, C$ .9348, euro 1.3460, sterling 2.001, Swiss .8133, ISK 62.91, rand 7.1706, krone 5.9488, SEK 6.8928, forint 184.14, zloty 2.8196, koruna 21.32, yen 123.17, sing 1.5380, HKD 7.8132, INR 40.937, China 7.6180, pesos 10.8396, dollar index 82.32, Silver $12.84, and Gold… $649.45

That’s it for today…Looks like the Cardinals finally found a good left handed pitcher. Unfortunately they lost a hard-fought game last night after 11 innings, but our new pitcher sure looked good! Jen is here again today, I have to hope she leaves early as I picked today as her due date. Full desk today, so it should be a good one!! Have a great Tuesday.

Chuck Butler — June 26, 2007

The Daily Reckoning