Increasing the Debt

And now…today’s Pfennig!

Increasing the Debt

Good day… And a Terrific Tuesday to you! Chris and I leave this morning, which means I’ll be writing from the road the rest of the week… UGH! I truly dislike doing that; it just takes so much time. Oh well… Here’s a thought for the day… Why do you want to put your “two cents” in, when it’s only a penny for your thoughts? HAHAHAHA!

Well… The currencies were downright boring yesterday, with little movement all day… There was some interesting news though. So let’s go to the tape, eh?

President Bush presented the first ever budget proposal that shows the government spending more than $3 trillion in a 12-month period… OUCH! Now that’s going to leave a mark! Let’s see now… If the government really spends $3.1 trillion and not a penny more, tax receipts are going to have to increase by the truckload. Unfortunately though, we’ve begun a recession, and tax receipts will be circling the bowl! So… Anyone in class want to tell me what that means for our current account deficit? And the bonus question is, what does that do to the plus $2 billion needed each day to finance the deficit?

By George, you’ve got it! There it is, in a nutshell. No, I take that back, we’re going to need the Grand Canyon to explain all this to the dollar bulls who are so darned set that this is the year for the dollar!

This budget proposal, along with the fact that it will have $150 billion added to it from the stimulus package, and the fact that the budget was already thought to exceed $250 billion next year, is now being adjusted upward… And not onward! The forecast for the budget deficit now sits at $410 billion this year… And $409 billion next year! Oh, and don’t forget that the war costs are not included in any of these numbers!

In Australia yesterday, the government announced that the trade deficit narrowed for a second consecutive month! They took $1.9 billion off the red side of the ledger in December. Australia is finally getting some traction on all the exports to China! This news came just in time for the Reserve Bank to make a rate hike at their meeting… Which is exactly what they did!

The Reserve Bank of Australia (RBA) gets a gold star for focusing on their country’s inflation and not worrying about a “global slowdown”. The RBA raised interest rates a quarter of a point, or 25 BPS, to the highest internal level in 11 years! That marks the third rate increase in the past six months, and they are all tied to inflation pressures.

I love it when a plan comes together, and it has come together for Australia. RBA Governor Stevens said that inflation was likely to remain relatively high in the short-term, but expected it to “moderate somewhat next year”.

As I said yesterday the Aussie (AUD) and kiwi (NZD) currencies and their high yields are really on a tear versus the dollar. Simply because you’re near me… No wait, simply because of their yield differential to the United States and for that matter the rest of the industrialized world!

And in New Zealand, wages grew at a record pace in the fourth quarter, which was a complete surprise to the “experts”. This wage growth has got to convince Central Bank Governor Bollard, that he cannot entertain thoughts of cutting rates this year. That means… The rate differentials are here to stay. Remember what I told you last week about something like this… If a currency can prove it will retain its rate differential, it has a fighting chance of offsetting the unwinding of the carry trade.

But… If those two market movers (high rates, and carry trades) cross streams… Lookout!

Look who else is gaining again on its rate differential to the dollar… The Canadian loonie (CAD) that’s who!

I really think these currency traders have got their wires crossed though. They are of the thinking that the Fed’s rate cuts will keep the United States from a recession. Ding, Ding, Ding, I’m sorry, that’s a wrong answer. Thank you for playing, we have a nice parting gift for you at the door! We are already in a recession! You can’t avert something you are already experiencing! I shake my head in disgust that these knuckleheads can’t see that.

Today, in the United States, we’ll see the color of the latest ISM non-manufacturing (Service Sector) index, which is expected to remain above the 50 level. This index has the same line in the sand at 50 as the manufacturing index has… So… We remain a service industry, whose service is horrible!

The carry trade lives… And now… We’ve even seen the carry trade running circles around stocks! Yes… Stocks are weaker recently, and the carry trade keeps on going, and going, and going… One of these days, the music is going to stop for these carry trade guys, and there aren’t going to be enough chairs for everyone.

Earlier this morning, there was some slippage in the euro (EUR) to below the 1.48 level… I haven’t really seen anything to describe this move. But while I’m on talking about the euro… I keep getting asked over and over again about my forecast for the euro… I’ve written about it a couple of times in the past, but for those of you who missed class that day… I have MY opinion on the euro’s direction in the near future and it goes like this… (That sounded like Chubby Checker… The name of the dance is the Peppermint Twist and it goes like this.)

First of all, whether the euro ever gets to 1.50 doesn’t mean it isn’t strong versus the dollar… 1.4750, which is where it stands this morning, is a far cry from 82-cents, eight years ago!

OK… I expect the euro to remain well bid for now, but experience a problem when the European Central Bank (ECB) finally gets around to cutting rates this spring (probably, May). The dent could take the euro to 1.40… But after getting past the initial blow of having lower rates, calmer heads will prevail and use this lower level as a springboard to push the euro higher. This is when I believe we will see 1.50.. But not before suffering some rough times.

Falling from present levels to 1.40, will be tough… Remember my “are you patient” talk? Well, you’ll have to be one patient dude, and dudette! But think of the bargains that might exist!

So, there you have it… There is opportunity in that scenario if it all plays out like that, eh?

One more thing before I head to the Big Finish… The Gulf States are rattling their swords once again, regarding dropping their dollar pegs. We’ve heard this all before, and they have all begun to sound like the boy who cried wolf! But just in case they’re not giving us another head fake. If the Gulf States like Saudi Arabia and the U.A.E. dropped their dollar pegs, they would choose to peg their currency to a basket of currencies, namely the euro. This would be good for euro… Bad for the dollar… But for now, we’ll treat this like the boy who cried wolf, one too many times

Currencies today: A$ .9060, kiwi .7925, C$ 1.0005, euro 1.4720 (it just slipped some more!), sterling 1.97, Swiss .9095, ISK 65.10, rand 7.4740, krone 5.4450, SEK 6.38, forint 175.11, zloty 2.4370, koruna 17.4150, yen 107.20, baht 31.09, sing 1.4150, HKD 7.80, INR 39.47, China 7.1840, pesos 10.79, BRL 1.7460, dollar index 75.85, Oil $89.30, Silver $16.52, and Gold…. $892.60

That’s it for today… Things were hot and heavy on the trading desk again yesterday… Makes for some very long days. I was packing last night, and thought, “This is crazy, packing all these clothes!” But then I remembered that I don’t get to come home until Sunday morning! UGH! What a long strange trip it’s been, and I haven’t even left yet! Traveling for me had already become a pain, and that was before I have a partially bionic leg and hip… Now I get to get taken aside, wanded, and patted down every time… Oh, boy! Where do I sign up for that! HA! But, you know… It is what it is… I take it in stride, because there’s nothing else I can do about it… Just wish I could be that way with currencies! OK, next Pfennig will be from Orlando… See you there, and I hope you have a Terrific Tuesday!

Chuck Butler
February 5, 2008

The Daily Reckoning