Income Outstrips Spending

Good day…I believe many of you finally received the Pfennig yesterday afternoon. As a quick explanation, one of our email server computers crashed last week causing problems with the delivery of the Pfennig. If you don’t receive the Pfennig in your email, you should always be able to view it online at Now on to the currency markets.

The dollar traded in a tight range yesterday and moved up just slightly overnight versus the euro and yen. European traders moved some money back into dollars on speculation that the consumer confidence numbers due out later today will show that U.S. consumers are again confident about the future of the economy. The main reason for this predicted increase in confidence is the falling gasoline prices. Gasoline prices dropped to the lowest level of the year in October (no coincidence the prices are down the month before the big election) and growth in jobs and wages extended, giving Americans the confidence to keep spending in spite of the slump in housing.

The dollar also gained some strength after reports yesterday showed income in the United States outstripped spending for a second month in a row. The gains in personal income of 0.5% were well above the estimate of 0.3 percent. Last months income figure was also revised upward from 0.3% to 0.4 percent. Personal spending, on the other hand, came in below estimates with a gain of only 0.1% compared to an estimate of 0.2 percent.

The number that the markets were keying on was the PCE deflator, which showed an easing of inflationary pressures. This is the Federal Reserve’s preferred measure of inflation, and should give them confidence to keep from raising rates further. The one FOMC member who voted for an increase in rates last meeting, Fed Bank of Richmond President Jeffrey Lacker, tried to keep the markets focused on the possibility of another rate increase.

As Chuck has written in the Pfennig, Lacker has dissented on each of the last three votes to keep rates unchanged, and he isn’t going to let one month’s decrease in the PCE deflator sway his opinion. He feels the economy is resilient enough right now for an additional rate increase. Apparently the rest of the FOMC doesn’t agree with him, but the dollar bulls love to hear him talk about further rate increases. As long as there is some member of the FOMC talking rate increase, these bulls will continue to support the dollar.

U.S. consumers aren’t the only ones confident about their economy. European’s confidence in the economy increased more than expected in October, underscoring the ECB’s concern that inflation will accelerate again from a two-year low. An index of sentiment among executives and consumers in the dozen nations sharing the euro rose to 110.3, the highest since February of 2001.

Inflation slowed to 1.6% in October, below the ECB’s 2% target as oil prices retreated. Even with the positive news on inflation, I think the ECB will take the precautionary move of another rate increase in December, as the European economy continues to expand at the fastest pace in six years.

As expected, the BOJ left rates unchanged overnight. The accompanying semi-annual report predicted that inflation will accelerate during the next fiscal year supporting the central bank’s case for further raising interest rates. The report highlighted Governor Fukui’s concern that prolonging a low-rate policy may spur excessive business investment as the economy emerges from more than seven years of deflation. Governor Fukui again said he couldn’t rule out another interest rate increase this year, which should give the yen some strength versus the U.S. dollar.

I continue to believe that the yen is one of the most undervalued currencies, and once the markets truly believe interest rates will be increasing in Japan, the carry trade will start unwinding and the yen will quickly move back up to its true value. If we do get another increase before year-end, we should easily see the yen trade back to 110 or better.

Readers know just how frustrating this yen has been for us on the desk. But we aren’t the only ones who are having trouble predicting where the yen will go. For example, today on Bloomberg, there were two headlines that appeared just minutes apart. The first read “Yen will drop to 120, Nomura Securities predicts” and the second read “Yen to Strengthen as Central Banks add it to Currency Reserves, ABN says.” I guess this is what makes markets.

Both of the commodity currencies ‘down under’ have held on to their recent strength. The Australian dollar is poised for its biggest monthly gain since April, as investors bet economic reports this week will confirm the Reserve Bank of Australia will raise rates a third time this year.

The New Zealand dollar held steady as business confidence rose to a 19-month high in October, again on the drop in oil prices. New Zealand kept interest rates unchanged last week, but rising business confidence adds to signs that growth will accelerate, forcing Governor Bollard to raise rates again next year.

And finally, India’s central bank raised its overnight lending rate for a fourth time this year, seeking to curb record consumer borrowing and restrain inflation in the world’s second fastest growing major economy. The markets largely expected this increase, so the Indian rupee moved up just slightly. This economy continues to grow at a tremendous pace and could have a major impact on the worldwide economy over the next few decades.

Currencies today: A$ .7689, kiwi .6655, C$ .8868, euro 1.2696, sterling 1.8987, Swiss .7991, ISK 68.09, rand 7.455, krone 6.5646, SEK 7.2539, forint 205.50, zloty 3.05, koruna 22.23, yen 117.86, baht 36.74, sing 1.5618, INR 45.03, China 7.8790, pesos 10.758, dollar index 85.80, Silver $12.07, and Gold… $602.35

That’s it for today… Chuck continues to be under the weather, so he is home trying to get some rest. Happy Halloween to everyone; make sure you drive carefully tonight as the trick-or-treaters don’t always look before running to the next house! Hope everyone has a great Tuesday.

Chuck Butler
October 31, 2006

The Daily Reckoning