No Surprises

Good day… Boston was great, but it sure is nice to be back home. No surprises from the central banks, as the BOE raised rates and the ECB stayed on the sidelines. The markets did get a surprise, as the ISM Non-manufacturing number came in well above expectations. We also got some good news on U.S. payrolls from ADP which increased 50% above expectations. This data sets up the monthly labor picture which is reported for June this morning. Expectations in the markets have now been raised, and the dollar will continue to rebound if the payroll figures come in stronger than expected.

June’s change in Nonfarm Payrolls is expected to increase 125K after last months 157K increase. The unemployment rate is expected to stay unchanged at 4.5% and the average hourly earnings figure is expected to remain at 0.3%. The average hourly earnings number is important, as wage gains need to continue for consumers to deal with near record gasoline prices and declining home values. With expectations raised, the dollar is set up for a drop if the numbers come in as expected or below.

As I mentioned above, the ECB kept rates unchanged but still hinted at further rate increases later this year. The euro (EUR) fell through the 1.36 handle on the combination of the positive U.S. data and the ECB decision. Trichet, in his speech after the rate announcement, had this to say about the future direction of rates: “Given the positive economic environment in the euro area, our monetary policy is still on the accommodative side, with overall financing conditions favorable, money and credit growth vigorous, and liquidity in the euro area ample. Looking ahead, acting in a firm and timely manner to ensure price stability in the medium run remains warranted. The governing council will monitor closely all developments to ensure that risks to price stability over the medium term do not materialize and medium to longer term inflation expectations remain solidly anchored at levels consistent with price stability.”

It would be tough to misinterpret Trichet’s intentions on rates. He will continue to raise them as long as the data supports it. And the data continues to show just how strong the European economy is. Manufacturing orders in Germany, Europe’s largest economy, increased more than forecast in May, led by demand from abroad. Orders rose 3.2% from April, when they dropped 1.6%. From a year earlier, orders advanced 7.5%. German companies certainly look as if they can withstand additional increases from the ECB. I don’t expect the fall below 1.36 by the euro to last, in fact disappointing jobs data could send it right back over 1.36 this morning.

The Bank of England raised its main interest rate to a six-year high as the fastest economic growth since the start of the decade is fueling inflation. The U.K. central bank increased its benchmark rate by a quarter-point yesterday in response to higher inflation. BOE Governor Mervyn King said, “the balance of risks” to price stability still “lie to the upside” amid “robust” global growth. The rate increases have yet to slow down the U.K. housing market, which has tripled in the past decade and helped fuel both consumer spending and a decade of uninterrupted economic growth.

The rate increase by the BOE was widely expected, so the pound sterling (GBP) only moved a bit after the announcement. It then retreated from near the strongest in 26 years as the U.S. economic reports came in above expectations. The pound sterling will probably range trade from $2.00 to $2.01 as it establishes a new “base”. The BOE will release the minutes of yesterday’s meeting in two weeks, and I wouldn’t expect any major moves by the pound before then.

The Swiss franc (CHF) held onto its recent gains as Swiss unemployment declined. The Swiss jobless rate fell to the lowest in almost five years as companies stepped up spending and hiring to meet orders. The jobless rate fell to 2.7%, the lowest since August 2002, from 2.8% when adjusted for seasonal swings. The Swiss economy is showing few signs of cooling from the fastest pace since the turn of the century with declining unemployment bolstering household’s optimism. Past rate hikes have had only little impact on the booming economy and there continue to be additional reasons to hike rates further. The Swiss franc will continue to move up versus the U.S. dollar.

Canada’s dollar (CAD) approached a three-decade high after a government report showed that employers added more jobs in June than analysts expected. This stronger job number fuels speculation that the Bank of Canada may raise interest rates more than once. Canadian policy makers, who last increased the rate 25 basis points to 4.25% in May 2006, next meet on July 10. With commodity prices supporting the Canadian economy, and rates expected to increase, the loonie looks set to march toward parity with the greenback.

The Japanese yen (JPY) fell as investors sold the currency putting money back into the “carry trades”. The yen has been sold by investors in spite of positive economic news, which should put pressure on the BOJ to increase rates later this year. Japan’s economic expansion will probably be sustained and the central bank will adjust interest rates by carefully studying the economy and prices, Governor Toshihiko Fukui said. “The Bank of Japan will implement monetary policy appropriately by closely examining economic and price data,” Fukui said today at a quarterly meeting of the bank’s regional branch managers in Tokyo. Two central bank policy makers this week said Japan’s borrowing costs, the lowest among major economies, need to rise to reflect the economy’s strength. The bank will probably keep the key rate at 0.5% at a meeting concluding July 12 and raise borrowing costs in August. This one delayed move will do little to impact the massive amount of short positions created by carry trade investors. So it looks like more of the same for the yen.

Currencies today: A$ .8562, kiwi .7825, C$ .9502, euro 1.3587, sterling 2.0092, Swiss .8188, ISK 61.41, rand 7.03, krone 5.8203, SEK 6.7381, forint 181.45, zloty 2.7720, koruna 21.0635, yen 123.23, sing 1.5217, HKD 7.8180, INR 40.44, China 7.6055, pesos 10.8056, dollar index 81.538, Silver $12.39, and Gold… $647.30

That’s it for today… Man is it ever hot here in St. Louis! It is great to be back on the desk, it can be difficult writing the Pfennig on the road. We are still a little short handed here, as Mike has accompanied Frank Trotter to Las Vegas for an investing conference. Got to get to work! Happy Friday, and I hope everyone has a great weekend.

Chuck Butler — July 06, 2007

The Daily Reckoning