Record Day in the Currency Markets

Good day… Or should I say “Great Day” for currency investors! Several record levels were reached overnight as the dollar continued its slide. The euro (EUR) traded all the way up to $1.5911, the Chinese renminbi (CNY) traded below 7, and the Singapore dollar (SGD) climbed to a record high. The yen (JPY) also made a big move up in value, flirting with the psychological 100 yen/$ barrier.

The big moves by the U.S. dollar came after the IMF cut its U.S. growth forecast and said the dollar was “somewhat on the strong side.” This IMF report, combined with the minutes of last month’s FOMC meeting confirmed that U.S. interest rates will continue to fall, while the ECB and other central banks will likely hold the line on further cuts due to inflation.

Speaking of inflation, former Federal Reserve Chairman Paul Volcker, famous for helping whip sky high inflation in the early 1980s was in the news earlier this week criticizing the current FOMC’s failure to deal with rising prices. Volcker said today’s economic conditions are not as severe as they were during his tenure, but still suggested caution about the threat of inflation and warned that the weak dollar is a major problem. He also gave Ben and his boys trouble about the Bear Stearns bailout.

Chuck spotted the article also and had this to say from down in Florida:

“And now… Did you see/hear about former Fed Chairman, and a fave of mine, Paul Volcker questioning the Fed’s legal powers in rescuing Bear Stearns? Let’s listen in…

“‘The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded Central Banking principles and practices.’ the former Fed Chairman went on to say…

“‘The extension of lending directly to non-banking financial institutions, while under the authority of nominally ‘temporary’ emergency powers… Will surely be interpreted as an implied promise of similar action in times of future turmoil.’

“But wait! Here’s the best part… Volcker said the modern fiscal system has ‘failed the test of time’ of the marketplace. When asked whether he predicts a ‘dollar crisis’ he said, ‘YOU DON’T HAVE TO PREDICT IT, YOU’RE IN IT.’

“WOW! Pulling an Aaron Neville and telling it like it is! Just like I do every day! But who am I compared to the former Fed Chairman? Like the old E.F. Hutton commercials… When Paul Volcker talks… People listen…

“Somebody said to me yesterday that they thought I was not fair to Big Al. I wasn’t trying to beat on him… I was simply pointing out that he seems to think this whole mess isn’t his fault. Well, it’s not entirely his fault… But as you used to say when the teacher broke up the fist fight… ‘He started it!'”

I guess Chuck won’t be invited over to Alan Greenspan’s for dinner anytime soon!

Inflation concerns were on the front page of the Wall Street Journal this morning but unfortunately our Fed just doesn’t feel they are in a position to deal with it right now. They have decided to take a path similar to their immediate predecessors, and pursue economic growth in spite of rising inflation. The problem is, all of their attempts at economic stimulus will continue to put upward pressure on inflation, and downward pressure on the dollar.

While the euro was rising to another record versus the dollar, the pound sterling (GBP) continued to slump, as the BOE followed the Fed’s lead and cut interest rates by a quarter point. This cut was widely predicted, as they are dealing with many of the same factors as the United States: a slumping housing market, banking credit crisis, and negative consumer confidence. The economic slowdown in England has encouraged policy makers to keep up the pace of rate cuts and set aside concerns about inflation, which reached a nine-month high in February. As I said earlier, they are in the same unenviable position as the U.S., with an economy that is in recession while inflation rises (can you say STAGFLATION?). We encouraged investors to exit positions in the pound sterling a while ago, and continue to believe the pound will follow the U.S. dollar down.

Another currency that seems to be following the dollar lately is the Canadian dollar (CAD), which fell to the lowest level in a week yesterday after the IMF report. The Canadian economy is just too tied in with the U.S. economy. So in spite of their abundance of natural resources, the Canadian currency will likely stay in a tight range with the U.S. dollar. I don’t expect it to fall dramatically, but it won’t move very far above parity with the U.S. dollar either.

The Japanese yen gained 1.6% versus the dollar yesterday and the Singapore dollar was up 1.5%. Both currencies rallied as hedge funds and other highly leveraged traders scrambled to reduce debts. These latest moves will be chalked up to carry trade reversals, but I think they should instead be classified as leverage reductions. The Bank of Japan held interest rates stable earlier this week so the rise wasn’t due to any interest rate differentials. Just think what the yen will do once the BOJ does start raising rates!

The Singapore dollar hit a record high as their central bank set a stronger trading range for the currency. The Monetary Authority of Singapore uses exchange rates instead of interest rates to manage their economy, so they let the currency move up to combat record inflation. Singapore’s economy expanded in the first quarter at the fastest pace since 2003 and the inflation rate was near a 26-year high at 6.5% in February. The latest move puts the Singapore dollar up 5.9% versus the U.S. dollar this year, making it the second best performer in the region outside Japan.

The Chinese renminbi was another currency that moved into record territory overnight, trading under 7 for the first time since it was floated in 2005. Like Singapore, China’s central bank is using a stronger currency to try and combat inflation, which jumped 8.7% in February versus a year earlier. It looks like China will continue to keep accelerating the pace of renminbi appreciation ahead of the Olympics. A stronger renminbi will help to keep a lid on inflation and will also appease some of the critics of China’s monetary policies. Just last week U.S. Treasury Secretary Hank Paulson said it was ‘dangerous’ for the exchange rate not to reflect the fundamentals of the world’s fastest growing major economy. Forward contracts show that traders are betting on an 11.2% appreciation for the renminbi during the next 12 months.

Currencies today 4/10/08: A$ .9337, kiwi .8013, C$ .9812, euro 1.5880, sterling 1.9787, Swiss .9912, ISK 72.99, rand 7.9164, krone 4.9966, SEK 5.9162, forint 159.67, zloty 2.1728, koruna 15.83, yen 100.18, baht 31.53, sing 1.3559, HKD 7.7892, INR 39.947, China 6.9916, pesos 10.5716, BRL 1.6906, dollar index 71.57, Oil $111.48, Silver $18.30, and Gold… $937.38

That’s it for today…Another great Cardinal game last night as Albert hit two home runs to beat Astros. Another rainy day here, and I hear we will have a ‘wintry mix’ this weekend! Typical springtime in St. Louis! I took a short run this morning and my legs are finally starting to feel a bit better after the marathon on Sunday. Hope everyone has a Thunderous Thursday, I know we will here, as the sky looks pretty dark.

Chris Gaffney
April 10, 2008

The Daily Reckoning