Paulson's Fix Missing a 'Silver Lining'

Good day… Chuck will be making his way back from sunny Florida today, and a wintry mix of ice and rain will be here to greet him. We had a wet and icy weekend here in St. Louis and it sounds like this weather is going to continue through much of our week. As usual, Chuck sent me his thoughts from the road for me to share with the Pfennig faithful. So I’ll start out with his comments on Paulson’s ‘rescue’ and the big employment numbers from last week:

“It’s Saturday night, and I’ve just finished talking to a crowd of over 300, with only a handful of current customers and Pfennig readers. When I was finished, I stayed around to give out applications, and the two boxes that were sent were gone in a flash!

“I’ve had a chance to really look over this ‘silver bullet’ subprime rate freeze, and something just doesn’t fit. The newspaper said it… The TV said it… And the radio is telling us that this freeze is going to help 1.2 million homeowners avoid foreclosure.

“Let me take you back to last August when Treasury Secretary Paulson said, ‘the subprime crisis was largely contained’… Or last May when Fed Chairman Big Ben Bernanke said, ‘the subprime mortgage crisis would have “limited” impact on the housing market, and there was “no serious broader, spillover” to the credit markets.’

“OK… Could two people that are considered smart, have been so WRONG? Could they be stretching the truth about 1.2 million helped now? Probably! I’ll bet a dollar to a Krispy Kreme that no more than 400,000 actually qualify for this help… Is that good that we helped 400,000? Yes… But I just don’t like the method used!

“The plan only covers those who took out mortgages for the beginning of 2005 through the end of this July, and haven’t been delinquent on their payments. Homeowners who’ve already sacrificed to pay the higher “reset” interest rates won’t get help. Nor will those who have missed mortgage payments, have already lost their homes, or obtained mortgages before or after the approved dates.

“And then there’s the final rub… The institutions that service these loans. They have contracts… And those contracts are for those loans with adjustable rates to go higher… All it will take for this to come crashing down like the house of cards it looks like, is for one servicer to file a lawsuit… Then there won’t be 1.2 million, there won’t be 400,000, there won’t be any – none, zilch, zero receiving help.

“OK, enough of that! How about the Jobs Jamboree on Friday? Didn’t I warn you that the markets had gotten all lathered up over the ADP report in error? Job creation for November was only 94K, over half of which were created out of thin air by the birth/death model… But the media got all ga-ga about it, didn’t they? All I heard on TV stations down on Marco Island was that the jobless rate didn’t rise! Holy make me feel good Batman!

“As I’ve said many times in the past… It takes at least 150K newly created jobs each month to keep an economy going. But don’t let that fact get in the way of a ‘feel good’ story by the media, eh?”

I think Chuck is dead on in his analysis of Secretary Paulson’s rescue! But the announcement sure gave the U.S. markets the shot in the arm that they needed. This week the markets are looking for another ‘fix’ from the Fed, as they have already priced in another 25 basis point cut in interest rates. I think that word fits the current situation perfectly, as the markets are like a drug addict who is constantly looking for his next fix. And like a drug addict, these quick fixes may make the economy feel good for a short while, but they are extremely bad for the market in the long term. While Bernanke may be able to keep the stock market happy and consumers spending for a while, the cuts are inflationary; and the mortgage loan bailout will not fix the subprime problems. The best way to protect your portfolio is to properly diversify out of the dollar.

Trading today will be dominated by the Feds rate decision on Tuesday, but we will also have the important retail sales and CPI numbers later in the week. The markets have already priced in a 0.25% cut, so look for dollar weakness if the cut is greater. I think the Fed will do just what the markets are looking for, so it really shouldn’t have too much of an impact on the range which we have been trading in recently. Before the big FOMC rate announcement, we will have the release of pending home sales today, which will likely show that the number of Americans signing contracts to buy previously owned homes, probably fell in October to the lowest in at least six years.

The retail sales number and CPI will have more of an impact, as they are expected to show a slight pick up in sales and inflation which would support smaller Fed cuts going forward. Any number that hints at a stronger U.S. economy could keep the dollar up through the end of the year. I agree with Chuck’s prediction last week that the currency markets are likely to just stay in a range through the end of the year. I don’t expect to see any dramatic moves like we saw in 2004, but maybe just a slow and steady move down for the dollar.

The euro (EUR) advanced against the dollar and the yen (JPY) after ECB rate setters raised concern about inflation. The euro reversed a drop versus the U.S. dollar after Erkki Liikanen, who is also governor of the Bank of Finland, said he sees increasing upside risks to inflation. The ECB continues to sound hawkish, and the data coming out of Europe shows that their economy is stronger than that of the United States. The euro should remain well supported by these differences in the direction of both interest rates and economic strength.

The Australian dollar (AUD) also gained over the weekend as investors started to work their way back into the carry trade. The Aussie dollar had lost 3.8% of its value over the past month as investors became concerned over the effect of a slowing U.S. economy. Australia’s economy depends on commodity exports to China and the rest of Asia, and many worry that a slowing U.S. economy will have a negative impact on China’s growth, and subsequently drop demand on these commodities. But recent data out of Europe show that consumers there will likely pick up some of the demand, and Asian markets will probably not drop as dramatically as some expected. There continues to be many reasons to expect stronger performance for the Australian dollar. The Reserve Bank of Australia left its benchmark rate unchanged last week, and base metals strengthened on Friday. While the Aussie dollar has hit a rough patch lately, the long-term prospects are still positive.

Currencies today: A$.8804, kiwi .7768, C$ .9947, euro 1.4714, sterling 2.0457, Swiss .8892, ISK 61.38, rand 6.6852, krone 5.4428, SEK 6.4069, forint 171.17, zloty 2.4317, koruna 17.6807, yen 111.79, baht 30.30, sing 1.4492, HKD 7.7964, INR 39.405, China 7.3953, pesos 10.8182, BRL 1.7589, dollar index 76.288, Silver $14.459, and Gold… $802.18

That’s it for today…Have to cut it a little short today, as we are short three people on the trade desk, and Mondays are always busy. I sure hope Chuck makes it back from Florida on time today, we are supposed to get some more nasty weather. I sure hope everyone has a Marvelous Monday, and a super start to their week.

Chris Gaffney
December 10, 2007

The Daily Reckoning