IFO Sends Euros Soaring Higher

Good day… And a Wonderful Wednesday to you! I had a long time friend – once a colleague and teammate on the company softball team – send me a note from Credit Suisse yesterday, that called for an end to the European currency strength versus the dollar. I love getting this stuff because, as they said in the Godfather… Keep your friends close, but your enemies closer… Yes, I like to see “their” side of the story.

In this case, it’s not too far off… While I think the European currencies, led by the euro (EUR), have more room to gain versus the dollar, you have to admit that the bulk of the euro’s gains are in the rear view mirror. But before everyone picks up their phones to call and sell their euros… WAIT! Think about this for a minute… The euro is the second most liquid currency in the world. It has taken over as the offset currency to the dollar. So… If the dollar were still going to weaken (which C.S. admitted it would), then the euro would see the offset trade. And… If the Asian currencies take over as the next shoe to drop for the dollar, as I’ve said they would for two years now, then the euro would see strength on the flip side of cross trades.

I’ve explained these cross trades before, but for the new readers, let’s review… Class, get out your #2 pencils… Currencies are traded in “pairs”. You are always shorting one currency and going long another currency. As U.S. investors, your base currency is dollars, so when you buy euros or yen (JPY), you are shorting the dollar and buying euros or yen. But U.S. investors aren’t the only players in this arena. You have investors around the world that have a different base currency… So you end up with “cross” trades – currencies that cross each other in this arena. Clear as mud? Sorry… This is the way I know how to explain it.

So… Euros, for instance, could gain in value due to people buying yen… On the crosses… And so on…

Alrighty then… I’m sure this will all sink in as you sink your teeth into your morning Honey Bun!

This morning, the euro has added to its gains from yesterday, as the German Business Confidence – as measured by the think tank, IFO – unexpectedly increased this month. I was all set to talk about the IFO being the more important measure of the German economy this morning, so… Let me go ahead and do just that! Yesterday, we saw weakness in the ZEW report on economic expectations… But that didn’t hurt the euro too much. The reason? The markets put more stock in the IFO report because it measures “current conditions” and therefore can be used as proxy for the European Central Bank (ECB) and their interest rates projections.

I saw a report on the IFO’s correlation with the euro’s past moves to higher ground… Made sense to me, as strong IFO reports came out right before the euro moved past previous big figures… Could certainly be the case again for the euro, eh?

So… The 1.56 level was taken out overnight, and as I write, the euro is trading well above the 1.57 level. Again, it’s too soon to tell if this is a “true reversal” of the sell off the past few weeks, or a false dawn… But to me, it certainly looks like we’re heading higher once again, and the negativism toward the U.S. dollar is slowly creeping back into the mindset of the markets.

The commodity currencies of Aussie (AUD), Canada (CAD), and Brazil (BRL) all “have it going for them” these days. Shoot Rudy, the Canadian loonie doesn’t even have the high interest rate like Aussie and Brazil, but with oil hitting $129 yesterday, it doesn’t seem to matter. I think that the markets have fully priced in one more rate cut from the Bank of Canada. With that out of the way, and commodities booming, the loonie could shake loose the pull down from the Bank of Canada!

I’ve heard a lot of talk about how people believe this commodity bull market is the latest “bubble”. Hmmm… That may be… But historically speaking, we’ve got a ways to go (time wise) before this bubble pops! Remember a month ago, when I kept telling you that the mass media didn’t know what they were talking about when they kept saying the bull market for commodities was over? I don’t hear these guys spouting off now. I wonder where they went? To hide under a rock?

I’m not going to dwell on this… But it just didn’t make sense to me that the bull market in commodities was over… And, now, we know why it didn’t make sense! Because it wasn’t over!

Second in command, Fed Head Kohn spoke yesterday, and sounded quite upbeat about the economy. Singing Ray Stevens… Everything is beautiful… What else did you expect? These guys have backed us into a corner that has three roads out… And none of them are a road to prosperity! 1. Inflation 2. Deflation 3. Stagflation… Oh… And they all merge with the recession highway!

Anyway… Fed Vice Chairman Kohn, speaking about interest rates said, “[it] appears to be appropriately calibrated for now to promote both rising employment and moderating inflation over the medium term.” The markets took this statement to mean Kohn was telling us that the Fed is unlikely to lower rates further.

Well… Baby, baby, it’s a wild world… And it’s hard to get by on just a smile. Kohn should be reminded of these words when the Fed comes back to the rate cut table later.

Speaking of the Fed… We’ll see the color of their last meeting minutes this afternoon. This was the meeting that they cut rates from 2.25% to 2%. I wonder if these meeting minutes will be in line with the press conference that was held after the rate cut… The reason I say this, is the suspicion I have toward the Fed after reading Bill Fleckenstein’s book, Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.

The Fed will also be releasing their new growth and inflation forecasts. This ought to be worth the price of admission folks. What yarn will they spin for us? I’ll bet they tell us the future is so bright we gotta wear shades! And inflation? Don’t worry about it! Yeah, when the Fed says, “Don’t worry about it” you had better run for the hills!

How about gold? Did you see that rise in gold yesterday? When I left it was up over $15 on the day. The London Exchange issued a report showing that demand for gold was down 16% in the first quarter. That makes abundant sense given the losses gold put on the books in the first quarter… But now that the markets are coming to their senses, and the dollar is weaker (while oil continues to set records every day), gold is back in demand.

And speaking of gold… Remember about a month or so ago, I told you about how the dollar’s weakness had caused so much loss of purchasing power for us, and illustrated it with this: If you purchased oil with euros instead of dollars, the price increase in oil would represent 92%, which sounds high right? Well, since you don’t purchase your oil in euros, but dollars instead, your price increase represents a 319% gain! Well… To take this exercise one step further… If you had purchased your oil with gold, your price increase would be 57%! Now tell me again, how gold isn’t doing its part to provide an inflation hedge?

I’m wondering when bond yields are going to rise… We’ve seen a basis point here and there, but nothing to write home about. When will the bond market finally see the inflation that’s ripping us apart? Obviously, when bond yields do rise, it won’t help the homeowners with ARMS coming due, or the ones that want to flip to a 30-year loan.

I used to be a “bond guy”, trading short-term treasuries, and commercial paper back in the early ’80 s when it was easy to put 18% yields in customer accounts. Then I moved to be a Foreign Bond Trader… But in recent years, I’ve lost touch with bonds… I mean, the yields were so low, who wouldn’t lose touch with them?

But I noticed on the yield curve sheet that our Foreign Bond Trader, John Kaupisch, puts out weekly, that yields in Australia can be locked in above 6%! WOW! OK, there’s a ton of disclaimers that need to go in if I talk any more about this, so I won’t… Except to say that foreign bonds are sold in our affiliate Brokerage, EverTrade Brokerage. Should you want to inquire more, just call 1-800-926-4922 and ask for John Kaupisch!

Well… Oil is over $130 today… The Dow was down 200 points yesterday… Gold was up $15 yesterday… And the euro gained a full cent. Do you feel the need to diversify your dollar denominated investment portfolio yet?

Currencies today 5/21/08: A$ .9645, kiwi .7805, C$ 1.0170, euro 1.5760, sterling 1.9660, Swiss .9705, ISK 73.43, rand 7.6575, krone 4.9775, SEK 5.9015, forint 154.25, zloty 2.15, koruna 15.9150, yen 103.30, baht 31.80, sing 1.3590, HKD 7.80, INR 42.82, China 6.9590, pesos 10.38, BRL 1.6480, dollar index 72.05, Oil $130.30, Silver $17.76, and Gold… $926.03

That’s it for today… Did you see that the Boston Red Sox pitcher, Jon Lester, pitched a no-hitter Monday night? John Lester is a cancer survivor… That means a lot to me. Tough day for yours truly yesterday…Llet’s hope today is better. We’re creeping up on Memorial Day weekend, which means that Friday will be void of volume, as the “boys” leave early to head to the Hamptons. Memorial Day is a good time to stop and look at what’s happened so far in 2008. It’s also a good time to get out the grill and get outside! Finally, we’ve turned the corner on weather here in St. Louis… Crazy weather year so far for sure! Time to hit the send button… I sure hope you have a Wonderful Wednesday!

Chuck Butler
May 21, 2008

The Daily Reckoning