Mortgage Delinquencies Move Higher

The currency markets were a bit more volatile than usual yesterday, but really didn’t do much until Europe got trading this morning and decided to punish the US dollar.

The data released yesterday morning was a mixed bag, as the leading indicators climbed for a fourth straight month and the Philadelphia fed reported a big jump in their gauge of activity, but the initial jobless claims unexpectedly rose. Unemployment in the US will continue to be a drag on the economy, slowing any recovery and possibly pushing the US back into recession (or as some predict a depression). Today we will get some news on the housing market, and while the media will pump up the fact that month on month sales continue to rise, another report released yesterday showed that mortgage delinquencies hit a record high in July. The proportion of homeowners delinquent on their mortgages or in foreclosure rose to its highest levels in four decades. An ominous sign for the US economy is that the problem loans have shifted away from the subprime borrowers to those driven into delinquency by unemployment. More than half the mortgages in the foreclosure process during the second quarter were prime loans. So while this morning’s data may show a bump up in monthly home sales, the US is still far from being out of the housing problems.

The European markets took the euro (EUR) higher against the dollar after reports showed German services and French manufacturing unexpectedly expanded in August. Another report showed that an index of German services industry grew for the first time in more than a year. This data confirms that the largest nation in the EU is pulling itself out of recession. The German services index rose to 54.1 from 48.1 and the French manufacturing index increased to 50.2 from July’s figure of 48.1. So both indices moved over the 50 mark, which is an indication of expansion. And the composite index of both services and manufacturing for the 16 nations sharing the euro moved to 50 from 47, another strong indication that Europe is starting to grow again.

I have read a number of articles and research reports that throw darts at the European Central bank for not being more aggressive with ‘quantitative easing’ and stimulus efforts. These latest reports indicate to me that the ECB may have played it ‘just right’. I know it won’t be clear sailing from here, and that the European recovery will still have some bumps, but the ECB left some powder dry and will be able to step in again if needed. And if the recovery sticks in Europe, the ECB won’t have nearly as much manufactured liquidity to pull in from the markets.

And I’m sure some readers will question how I can trumpet the recovery in Europe while at the same time believing that the recovery here in the US won’t have legs. The main difference is what is fueling these recoveries. While many, including your current Pfennig writer, are in the opinion that the nascent recovery here in the US has mainly been driven by government stimulus; you can’t say the recovery in Germany and France is being driven by government intervention. Digging into the recent positive data here in the US shows that the government is responsible for most of the spending; the private sector has largely stayed on the sidelines. The recovery in Europe, on the other hand, is being fueled by increased consumer confidence and internal private sector demand. In fact, many of the dollar bulls have continually chastised the European governments for not taking a more aggressive role in providing stimulus to their economies.

England and the US have yet to feel the inflationary impact of their budget busting ‘quantitative easing’ programs; but believe me, inflation is lurking just around the corner. While the US’s Bernanke and UK’s Darling have chosen to ignore the future consequences of these programs, Trichet and the ECB always kept a hawkish eye looking toward the future.

Currency traders got excited about these European data releases and took the euro back above 1.43. As Chuck would say, the big dog started to move and the rest of the pack followed suit. The leaders versus the US dollar were the Nordic currencies of Sweden (SEK), Norway (NOK), and Denmark which were 1,2, and 3 overnight versus the US dollar. Even the Swiss franc (CHF) showed some strength, matching the move up by the euro.

The Norwegian currency probably benefitted a bit from an article that ran in The Economist magazine. The article was entitled “Which central bank will raise interest rates first?” and pointed out the most likely candidates were Australia and Norway. I believe The Pfennig pointed this out a few weeks ago, but for now The Economist has a bit more readers than The Pfennig, so the article probably had a bit more of an impact on the markets. The article points to the brightening economic picture for both of these countries and the fact that “Because both countries primarily export staples like raw materials and food, their sales abroad have held up relatively well. Australia in particular benefits from Asian customers whose economies have remained pretty robust.” The magazine predicts that Norway will likely be the first to raise rates.

Long time readers of The Pfennig will recall that the direction of interest rates was at one time the largest determinant of currency movements. Those countries with central banks that were looking to raise rates were the favorite of investors. Nations with central banks who were ‘in front’ of the inflation curve and raising rates to combat future inflation were the best places to invest during this time period. Lately the currency markets have been trading on risk aversion, with bad economic news pushing investors toward the dollar, and positive news moving them back into higher yielding assets. As the global recession eases, I would look for the currency markets to return to past trends, and reward those currencies that have rising interest rates. Australia seems poised to benefit under either scenario, as they are already in the ‘higher yields’ camp and are also predicted to move these rates even higher.

No big news out of the boondoggle in Jackson Hole – not that I expect any! There was one story that caught my eye yesterday regarding the meeting. Mohamed El-Erian, the CEO of bond giant PIMCO, was on the news wires with suggestions for the central bankers meeting in Jackson Hole. He is apparently worried about the disjointed approach these central bankers have taken in their intervention with the markets and believes the approach will lead to volatile markets and slower global growth. He also believes we are in for a drop in the value of the US dollar. “The question is not whether the dollar will weaken over time, but how it will weaken,” said El-Erian. “The real risk is that you will get a disorderly decline.” According to El-Erian, the euro will rise to $1.60 by the end of 2010 and the Canadian dollar (CAD) will appreciate to 1.01.

And finally, the Mexican central bank will probably keep their interest rates unchanged at their meeting today. Inflation, which has been running above their target level, will prevent policy makers from cutting the benchmark rates to stimulate their economy. The Mexican peso (MXN) has turned in a good month, even outperforming the popular Brazilian real (BRL) and Australian dollar (AUD). But don’t get too excited, Mexico is still very dependent on a strong US market, and at least some of this appreciation has been due to rising oil prices.

Speaking of oil, crude ran through another milestone yesterday hitting the high for the year. Oil exporters such as Norway, Brazil, Mexico, and Australia should continue to benefit from these higher prices. But the other commodities we track, gold and silver, seem to be stuck in a range. Silver seems especially cheap compared to gold right now, and both are good hedges against future inflation. I have to believe both are set for a breakout on the upside at some time down the road.

The Daily Reckoning