Rate Talk Drives Dollar Down

Good day… Chuck got on a plane first thing this morning, but before he left, he sent me the following thoughts on the currency movements we saw yesterday:

Interest rate outlooks for the Eurozone and United Kingdom came back into play yesterday, as the euro and pound sterling both saw half-cent gains on the day.

We didn’t hear anything new and exciting from the Fed Heads that were out in force yesterday, so the markets preferred to focus on the two Central Banks that have drawn their respective swords against inflation, either realized or forecast!

I’ve long been a fan of Central Banks that draw their respective swords against inflation before they fall behind the inflation eight ball. The Reserve Banks of Australia and New Zealand were (and still are) famous for this type of interest rate policy.

You see, dear reader, it simply comes down to whether the Central Bank has a desire to provide price stability or not. Obviously, we can draw a line in the sand on this one, eh? The Central Banks of the European Union, United Kingdom, Sweden, Norway, Switzerland, Australia and New Zealand all stand on the side of the line that designates “PROVIDING PRICE STABILITY”. And the Fed and Treasury stand on the other side of the line!

Someone asked me about Iceland yesterday… And I admit to being somewhat remiss in talking about Iceland lately. My bad! However, it wasn’t as though I was hiding “bad news!” No! The Icelandic kroner has been stealth-like recently, but all good! Here are my thoughts on whether the kroner can maintain this strength.

As long as the emerging markets don’t go into a meltdown… And the carry trade continues to push buyers into the high yielding currencies like kroner and kiwi, the kroner should remain well bid. Of course, this is not to say this is a one-way trade… Or that owning kroner isn’t without risk.

Get out the hand held mirror and put it up against the Icelandic kroner, and you’ll see Japanese yen in the mirror’s reflection… As long as the carry trade exists… Yen will be offered, and that’s what keeps the yen weak. Of course, the Bank of Japan could go a long way toward removing the yen’s weakness by raising interest rates. But, that just doesn’t look as though it is going to happen any time soon.

Today, we’ll see the color of the latest U.S. productivity report. Long time readers know how much I dislike this report, because of the nature of the report. It basically implies that workers work harder for the same pay, when productivity is strong. Productivity was down in the third quarter… So, I expect it to have rebounded in the fourth quarter… When productivity is strong, the Fed uses the result as an indication of no wage pressures in the pipeline. So… A strong productivity would actually be dollar negative. But who knows which way the traders end up taking this one!!

As expected, the Australian central bank left rates unchanged at a six-year high today after consumer prices fell for the first time in eight years. Falling fuel and fruit costs drove down consumer prices at the end of 2006, dousing expectations of another rate increase this year. The Aussie dollar continues to be one of the most popular investments offered by EverBank, as it combines a currency which looks to continue to appreciate with an interest rate which is slightly higher than here in the United States.

The upcoming G7 meeting continues to garner media attention, but nothing noteworthy is being said. Japanese officials continue to try and push the expected debate over the value of the yen toward a discussion of the Chinese Renminbi. European officials meanwhile have pressed for weakness in Japan’s currency to be discussed at the meeting on February 9-10. The G-7 always issues a joint communiqué, which includes a section on foreign exchange at the end of its meetings. The value of the yen and Chinese reniminbi will likely be a major part of this report. Treasury Secretary Paulson has defended Japan’s and China’s policies over the last week, so we will have to see just how much impact he will have on the meetings. We will likely see more weakness in the value of the dollar at the end of the meetings, as the yen and renminbi will likely see some buying.

Currencies today: A$ .7780, kiwi .6830, C$ .8450, euro 1.2988, sterling 1.9715, Swiss .8062, ISK 67.97, rand 7.1885, krone 6.2291, SEK 7.013, forint 194.78, zloty 2.9771, koruna 21.67, yen 120.68, baht 34.42, sing 1.5329, HKD 7.8125, INR 44.12, China 7.7474, pesos 10.93, dollar index 84.79, Silver $13.62, and Gold… $653.55

That’s it for today… Thanks to Chuck for writing a majority of the Pfennig for me this morning. Got to get out the door to catch a plane to Orlando (I’ll get my Wednesday Starbucks at the airport). The desk will be shorthanded the next three days, so try and take it easy on them. Can’t wait to get to Florida and away from the deep freeze, which has gripped the St. Louis area. Have a great Wired Wednesday!!

Chuck Butler — February 07, 2007

The Daily Reckoning