Preparing for G-7

Good day… As in the past, I will start today’s Pfennig with Chuck’s thoughts:

“OK… So, more correction in the currency markets yesterday as the euro (EUR) lost the 1.41 handle. But again, in my eyes, this is just a technical correction to correct an oversold dollar. Talk about being able to buy cheaper this week versus last week!

“I’ve heard that some yellow-bellied traders were selling euros ahead of the G-7 meeting, as they are concerned that the G-7 ministers are going to express concern with the strength of the euro… But by the time they meet, the euro will probably be at least 2.5-euros cheaper! What a collection of mental giants! But that’s OK… I’m sure that they had profits lined up across the board in the currencies!

“If I were a Eurozone minister I would be screaming at the top of my lungs about the weakness of yen (JPY), renminbi (CNY), and the dollar! I wouldn’t whine about how strong my currency is… I would talk about how weak theirs is! And finally on G-7, like I said yesterday, the United States should be trying to talk up the dollar… But do you seriously believe that U.S. Treasury Secretary Paulson will do so? Not me! He’ll whine about renminbi, and leave yen alone.

“I was interviewed yesterday by U.S. Banker. And the interview was really a survey they do every year, asking me my thoughts about everything from housing, jobs, the economy, to the Dow for the remainder of this year and all of 2008. They will average this stuff out, and put it in print at a later date… So, when it comes out, you see the ranges of things, and whatever the lowest number for the economy is… That’s me!

“They did ask me about currencies, which I thought they would never get around to… So, the interview wasn’t a complete loss!

“Speaking of the economy… They asked me if I thought we would see a recession in the next year. And I said… Drum roll, please… YES! The mortgage mess is going to continue on throughout 2008 I told them, and the Fed will cut rates three more times in 2008, putting rates at the end of 2008 at 3.5%. Nobody knows… And I certainly know nothing more than anyone else except to call a bubble a bubble and a meltdown a meltdown, and not get all rose colored glasses by the propaganda the Fed was feeding us for most of this year!

“OK… ISM non-Manufacturing slipped last month, but remains expansionary… Which tells me that we are so ‘into’ the service game here in the United States now that we don’t manufacture things like we used to here.

“We also saw the ADP payroll data, which is sometimes useful in gauging what the National Jobs Jamboree will come out looking like. Well… The ADP report was a bit weaker than expected for September and the August print was revised downward. The Actual September number was plus 58K, and the revised August print was plus 27K.

“So, using how last month’s number compared to the Jobs Jamboree print of negative 4K, we could see this month’s print for September come in at around 80K. I saw one BIG TIME DEALER call for plus 175K… I don’t think it will be that high, but I do think it will rebound from last month’s print.

“80K, should be weak enough to keep the Fed at the rate cut table… And get the dollar back on the weak track.

“The European Central Bank (ECB) meets today to discuss interest rates. Before the credit meltdown in August, I would have said to expect a rate hike… But not now. Expect ECB President Trichet to still talk tough though… He has learned his lessons well, and will not show his hand at this time.

“The Bank Of England (BOE) is also meeting this morning and while some think the BOE is ripe for a rate cut… I don’t! I think the BOE will cut rates before year-end… But not now.

“So… Look for more dollar strength for now… But not for too much longer.”

Obviously Chuck wrote his contribution to this morning’s Pfennig last night, and he was right on with his call the BOE would leave rates unchanged. BOE policy makers want to see what impact higher credit costs will have on their economy before making any moves. The decision follows panic among depositors at Northern Rock after money market rates jumped and the bank was unable to fund its business. The run on the lender, the first in more than a century, has sparked criticism of the way the central bank handled the credit crunch. Many are calling for a rate cut by the BOE by November, and this view was strengthened by a report released this morning, which showed that U.K. house prices fell in September for the first time in nine months. The pound (GBP) looks like it will hold onto the $2 handle, but we don’t look for better gains from the euro or Nordic currencies going forward.

The ECB will also announce their rate decision this morning, but the markets have already assumed there will be no change in rates at this meeting. ECB policy makers, like those at the BOE, will delay any rate decision while waiting to see the impact of the recent credit crunch. But unlike their brethren at the BOE, I expect the European council members to continue with their tightening bias. Rising credit costs prompted the ECB to shelve a planned rate increase last month, and the euro’s climb to a record against the dollar has clouded the outlook for economic growth. But policy makers are still concerned inflation will accelerate: Last month, consumer price increases breached the ECB’s 2% ceiling for the first time in more than a year.

There are signals that economic growth in the euro area will slow due to the stronger euro and credit crunch. The European Commission said in a report released today that rising credit costs might curb economic growth in Europe next year by 0.3%. Statistics offices in both Germany and France predicted growth in their respective economies would be less than the third quarter of last year. But the ECB’s leaders still don’t seemed convinced that inflation will reverse. Inflation accelerated to 2.1% from 1.7% a month earlier, and unemployment is at a record low. ECB President Trichet said October first that the “euro area has become more resilient to external developments” and Vice President Lucas Papademos said last week that the impact on growth from market turbulence would be limited. I think we could see another rate increase before year-end, and the euro will benefit.

The Bank of Japan is using the recent credit crisis to keep interest rates at record lows. Bank of Japan Deputy Governor Kazumasa Iwata said financial market turmoil and a slowdown in the United States would hurt the world’s second largest economy. Iwata was the sole dissenter when the board raised the benchmark overnight rate in February, and he continues to call for the BOJ to leave rates where they are. But others in Japan are still calling for additional rate increases. Data in Japan has been somewhat mixed but shows the economy is still growing and inflationary pressures are again building. But with any additional rate increases for 2007 now in question, the yen will likely remain undervalued through the end of the year, and encourage additional investments in the ‘carry trade’.

The other funding currency for this carry trade, the Swiss Franc (CHF), continued to break away from the yen and actually rose yesterday. The franc rebounded from a two-week low as stocks in Europe and Asia dropped, making investors wary of borrowing in Switzerland and converting the proceeds to a currency they can invest for a higher return, the ‘carry trade’. The Swiss economy has been strengthening and the Swiss central bank raised interest rates on September 13. The Swiss franc looks like a good currency to own going forward and should benefit any time risk aversion creeps back into the markets.

The two most recent additions to our currency investment choices are the emerging market currencies of India and Brazil. So far this year, these emerging market currencies along with the Icelandic krona have been some of the best returning currency choices, with Brazil (BRL) up 16.63%, Iceland (ISK) up 15.65%, and Indian rupee (INR) up 12.12% versus the U.S. dollar. India’s rupee rose to the strongest in more than nine years. The rupee has benefited from an increase in the investments into their financial markets and the long-term trend is for a stronger rupee. Both India and Brazil have been untouched by the subprime mortgage problem and investors will likely continue to chase the higher yields.

Currencies today: A$.8848, kiwi .7529, C$ 1.002, euro 1.4107, sterling 2.0356, Swiss .8480, ISK 61.46, rand 6.9299, krone 5.4438, SEK 6.5046, forint 178.96, zloty 2.6727, koruna 19.5257, yen 116.65, baht 31.50, sing 1.4812, HKD 7.7565, INR 39.49, China 7.5060, pesos 10.9067, BRL 1.8405, dollar index .7854, Silver $13.185, and Gold… $725.20

That’s it for today… The baseball playoffs started last night, and it was sad not to have our Cardinals playing. Chuck says he is doing fine, but has to get a daily blood draw, so he is starting to feel like a pincushion again. The St. Louis Blues start their season tonight; hopefully they will be the team that can bring St. Louis out of our professional sports slump! Hope everyone has a tremendous Thursday!

Chris Gaffney
October 4, 2007

The Daily Reckoning