Removing Fed Rate Hike Bets

Good day… And a Happy Friday to one and all! Looks like it could be a Fantastico Friday as traders are finally coming around to Chuck’s way of thinking regarding Fed rate hikes… And as traders remove their bets for aggressive Fed rate hikes, the luster begins to fade on the dollar rally. The meetings are over for this week (they start up again next week!), YAHOO! I get to spend the day on the trading desk… I’ve missed everyone!

OK… Front and center this morning, we have the euro (EUR) trading 1-cent higher, knock, knock knocking on Heaven’s Door, I mean, the 1.56 handle. As I said in the intro, it appears that traders don’t have the stomach to hold on to their bets that the Fed will aggressively raise interest rates this year. Recall, the other day, I told you that the bets were ratcheting up and had reached 75 BPS of rate hikes this year… I doubt we have any. In fact, as I told you the other day too, I believe that when the dust settles on the fact that the Fed isn’t going to raise rates, things will have gotten so bad here that the Fed will be entertaining thoughts of cutting rates again!

Japanese yen (JPY) had really been beaten about the head and shoulders this past week, as it re-visited the 108 handle… But with the stocks looking soft, it recovered a bit the past two days. The Royal Bank of Canada (RBC) says that the dollar is overbought versus the yen. Hmmm… I agree with that, but I think RBC’s call for a yen rally to 105.60 is not enough. That’s too conservative for me… But then, I get emotional about these things. I called for yen to rally to 100 this year, and while it got very close, it didn’t quite have the strength needed to reach that level. I based that call to 100 on the fact that we would have another “risk” event in the markets this year, which would lead to risk aversion, stock selling, carry trade reversal, and a yen rally! We still have half a year to go, but the year is moving fast!

Speaking of the carry trade… I receive dozens of emails each week from people asking me what the carry trade is… For long time readers, we’ve been through all this more times than you can count… But for new readers, well… It’s all new! So here you go! The carry trade is basically selling a low yielding currency (whose borrowing costs would be low) short, and taking the proceeds to buy a higher yielding asset. When the borrowing costs go up, or when the currency that was sold short rallies, it makes this trade very costly, and it then gets unwound/taken off.

OK… Back to currencies… Yesterday, I told you about Brazil’s Central Bank chief, and his calling out the Bank of England’s handling of inflation… Well, Mr. King of the Bank of England (BOE) heard that and came out with his own strong words… King said in an interview that the BOE needs to focus on rising inflation, not growth… OK… I’m with you there! The markets will take that to mean higher interest rates, considering the fact that inflation is well over the BOE’s 2% ceiling. And when that thought process enters the markets, the pound sterling (GBP) will be underpinned, and in fact it is rallying as I type my fat little finger to the bone here!

Here’s a story I doubt you saw on your news station yesterday… China said it will raise domestic gasoline and diesel prices by 17%-18%, as it responds to near-record crude-oil futures and criticism of its fuel subsidies. The surprise move is the largest increase in over four years, although local prices will still be below the international market. In case you weren’t aware… The Chinese government subsidizes fuel prices for their people… You see a country that has over $1 trillion in currency reserves can afford to do that! However, with the price of oil continuing to rise, even the Chinese had to say “no mas!”

I doubt this will be too heavy a load for the Chinese economy to bear… He ain’t heavy, he’s my brother! So… Expect the beat to go on in China, which means a slow, drip of currency appreciation at a time.

This news led oil prices lower for the day… And that’s OK in my books! And looky there! The euro just went back above the 1.56 handle! No more knocking… Someone’s knocking at the door, somebody’s ringing the bell; do me a favor, open the door and let them in… Why hello, Mr. Euro! How are you today? It’s good to see you back in the 1.56 neighborhood! Why thank you… It’s good to be back… I was lost in the 1.53 block for a long time, and people kept telling me I wasn’t worthy any longer, but I sure showed them, eh? HAHAHAHAHAHAHA!

OK, I’m back now, that was silly… But, you know me, once I get typing, I can’t stop, it’s simply a stream of consciousness!

Bank of Canada’s (BOC) Governor Carney gave a speech last night, that should be quite the underpin for the Canadian dollar/loonie (CAD). Carney indicated that the BOC was finished with their rate cuts and have moved to a neutral bias. He also talked about how a strong loonie would help exert a “dis-inflationary” influence. The loonie took notice and is rallying this morning.

Yesterday, we saw the color of the latest Philly Fed Index (manufacturing in that region), and it looked awful! The Index was “expected” to fall to negative -10, but instead it fell to negative -17… Uh-Oh! This leaves this index near the lows of earlier in the year. Significantly worse levels have occurred only in outright recessions. And you know me… I contend this to be a recession!

The data cupboard is bare today… No data, nothing, nada, zilch! And for the dollar, that’s probably a case of “no news is good news”!

Next week we’ll have the first Fed FOMC meeting since Big Ben began “fighting inflation”. The markets will be greatly disappointed when they leave rates unchanged, and leave the “downside growth risks” on the board… But don’t let that get in the way of dollar bulls still thinking they have the upper hand here… Too bad they’ll get that hand slapped next week (and the following weeks) when the Fed continues to do nothing, absolutely nothing, say it again!

Did you see that the ratings agency, Moody’s, announced that they were cutting the ratings of MBIA and Ambac, citing impaired ability to raise capital and write new business? Well… Just another item being swept under the rug! But you can depend on me to pull back the rug and expose these things!

And… Has anyone seen the warnings issued by the Royal Bank of Scotland (RBS)? Pretty scary stuff for a conservative bank to make this kind of a call, but they did, and I’m proud of them for going out on the limb! It gets lonely out on the limb all by yourself! Here’s the meat of the warning…

“The Royal Bank of Scotland, warned clients to be prepared for the biggest crash in stock and credit markets in the next three months as inflation and the dwindling fiscal growth continues to hit [the] world economy. The views were expressed in a report by the bank’s strategists Bob Janjuah, Kit Juckes, Tim Jagger and Richard Smith.

“The report stated, ‘Our macro economic road map is playing out – slow growth for longer, deep into 2009, with the pain spreading globally, gradually.'”

Well… That warning plays well with my warning that another “risk event” will play out in the United States this year… The liquidity/credit crunch losses booked so far will turn out to be merely the appetizer to this four course meal! Of course that’s my opinion… I could be wrong.

And… These investigations of the failed Bear Stearns hedge funds are getting interesting. Two former hedge fund managers have been arrested, and the prosecutors believe they have a “mountain” of evidence to show that the managers mislead investors and lenders. Like I said a couple of months ago, I think this mortgage meltdown/subprime debacle will eventually lead us to corporate scandals much like we saw in the early part of this decade.

Does that matter? Well… When you’re a country such as the United States, depending on the kindness of strangers to buy their assets to finance their gargantuan DEFICIT, it SHOULD matter! If those strangers (foreigners) don’t feel as though the assets they are buying have credibility, they won’t buy… And that leads us back into the circle of when you can’t finance your deficit; then you have to either raise interest rates aggressively or continue to allow a general debasement of your currency.

Alrighty then! The dollar looks as though it will end the week on a sour note, and we’ll head into next week with the focus on the Fed’s FOMC on Wednesday… And I noticed yesterday, before I left, that gold had rallied back to $900! I like the looks of that figure! Time to go to the Big Finish!

Currencies today 6/20/08: A$ .9550, kiwi .7640, C$ .9870, euro 1.5615, sterling 1.9770, Swiss .9660, ISK 80.30, rand 7.9770, krone 5.15, SEK 6.0125, forint 153, zloty 2.1550, koruna 15.45, yen 107.50, baht 33.40, sing 1.3650, HKD 7.8050, INR 42.96, China 6.88, pesos 10.30, BRL 1.6030, dollar index 73.06, Oil $132.90, Silver $17.50, and Gold… $904.50

That’s it for today… I guess I spoke too soon about that Chamber of Commerce weather yesterday, as it is raining again this morning! UGH! Next Saturday, the 28th, is my little buddy, Alex’s birthday… We are traveling to Kansas City to watch the Cardinals play the Royals for his birthday. (That’s what he wanted! And you won’t hear me arguing about a chance to watch my beloved Cardinals play!) The only reason I talk about this now is that someone mentioned yesterday that they couldn’t believe he will turn 13 this year. And it hit me! 13? It just seems like a few years ago that he used to sit on my lap and “help” me write the Pfennig each morning! WOW! Time flies when you’re having fun, eh? Alex is becoming quite the guitar player, plays football and baseball, and loves to watch the Cardinals. Hmmmm sounds like a chip off the old block, eh? Maybe in a couple of years I’ll let him take a stab at writing the Pfennig one day… That would be a hoot! Anyway… I hope this Fantastico Friday continues, and you have a Wonderful Weekend!

Chuck Butler
June 20, 2008

The Daily Reckoning