S&P Cuts Japan's Sovereign Rating Outlook

Right off the bat, the market mover yesterday, as promised, was the press conference following the Fed meeting. We basically had all of the markets holding their collective breath until they were blue in the face just waiting for Ben Bernanke’s speech before they took a gasp of air. Once the rate decision was announced and Ben began speaking, the floodgates opened. By this, I mean wide open. It was like a dam had broken apart and swept the dollar right on down the river with no chance to get to higher ground.

Before I head into the market movement, let me first get you up to speed on what actually happened with the Fed meeting. There really weren’t any curveballs thrown into the mix so it was pretty much what was expected. They kept the term “moderate pace” as the description of the economic recovery and continue to view inflation as temporary in nature. The cause of higher inflation is primarily being placed on the shoulders of commodities, namely oil, and food prices.

One of the obvious risks here is that commodity prices remain elevated for a longer period than what the Fed expects and has a broad spillover effect on the economy. Just ask the ECB about so called “transitory inflation.” They took the bull by the horns in an attempt to make sure they aren’t scrambling around when it’s too late. Commodities have also been tied to global growth. The trend has been higher growth feeding higher commodity prices and lower growth causing a fall in commodity prices. So does this mean the Fed expects lower growth?

I guess part of that question can be answered with the Fed’s reduction in their economic growth outlook. They lowered the range of expansion here in the US down to 3.1%-3.3% from the previous estimate given back in January of 3.4%-3.9%. The high end of January’s estimate seemed like wishful thinking anyway, but we would need to have global growth see the same type of downward revision if lower commodity prices would have any type of staying power.

The key focus surrounding the Fed meeting was QE2 and its future. While the end of round two in June was confirmed, Bernanke signaled that record stimulus will be maintained until job growth can stand on its own two feet and that a recovery is showing enough to withstand tighter credit. Chuck gave me some insight to share as well, so here you go…

Well, folks… Earlier this week I told you that: I expected the FOMC to say that they would be keeping the QE2 bond buying going until the scheduled end of June, and that they would keep interest rates unchanged. Yesterday, The US Federal Reserve signaled the end of its controversial $600 billion bond-buying program as planned, setting the stage for challenging decisions about whether to raise interest rates in the face of both high unemployment and looming threats of inflation.

Remember… I also told you that when it all ends, at the end of June, the markets are going to take it as a “sign” from the FOMC that everything is beautiful. When the markets feel this way, there could very well be a rush to the safe haven dollar once again, which would hurt currencies and commodities, including gold and silver… But it would only be a temporary scenario, lasting only as long as it takes for the markets to realize that the emperor has no clothes without stimulus… Which is when the Fed pulls QE back out of the closet, for the third round… and it’s at that point, that the dollar gets sold once again…

So, as an investor in currencies and commodities, you can stay the course, batten down the hatches and ride the storm out REO style… Or… You can sell ahead of June’s Close, and look to purchase again when the dust settles on this whole scenario…

Thanks to Chuck for sending those thoughts from way down south. I think I’ve gone on long enough about the Fed, so let’s move over to the durable goods numbers from yesterday. Demand for long lasting equipment rose higher than expected by posting a 2.5% increase and represented a third straight month of gains after the February figure was revised up to a positive 0.70%. Global demand and a weak dollar continue to keep factories busy on the export side but US companies have also been investing in capital equipment so far this year to take advantage of the new tax code that allows for 100% depreciation on certain items.

As I mentioned yesterday, the manufacturing sector has been one of the few areas of sustained improvement and should remain intact as long as global growth persists. There won’t be any shortage of data to look at today as we have the initial printing of first quarter GDP, personal consumption, and core PCE (which is an inflation measure). Since it’s a Thursday, we also have both the initial and continuing jobless claims, which are expected to show slight improvements. We then cap it all off with Bloomberg’s consumer comfort report and pending home sales. It looks like I’ll have a lot to talk about in the data department tomorrow.

Switching gears to the currencies, the dollar saw a significant round of selling yesterday as the dollar index traded below 73.30. The Fed announcement sent most of the currencies higher yesterday as confirmation interest rates in the US weren’t moving upward anytime soon. The rand (ZAR) turned in the best performance on the day by rising about 1.25% not only on interest rate differentials but also gold trading at new record highs. There were only two currencies that ended the day lower, which were the Japanese yen (JPY) and Brazilian real (BRL).

The yen lost about 0.75% yesterday as S&P cut Japan’s sovereign rating outlook. While it’s just the outlook and not an actual rating cut, S&P is concerned about the costs associated with the quake rebuilding efforts adding to their already heavy debt load. They estimate it could cost as much as 50 trillion yen ($611 billion) to rebuild and move the debt-to-GDP ratio up to 145% in 2013. If that wasn’t bad enough, retail sales for March fell the most in 13 years and could get even worse. Chuck also had some thoughts to share on Japan, so here he is…

Remember the Beatles song: I don’t want to spoil the party so I’ll go… I would hate my disappointment to show, there’s nothing for me here, so I’ll just disappear…?

That must have been the song they’ve been singing at the credit agencies for the past decade! But, now that the girl failed to show up for the party, they’ve decided to come to the party late! After downgrading the outlook to negative last week for the US… S&P followed up that bomb with another, downgrading Japan’s outlook to negative… Isn’t that sort of like pouring salt in one’s wound? S&P cited the earthquake in Japan as one of their reasons for the downgrade! Memo to S&P… Just like the US, Japan’s outlook should have been downgraded years ago!

If you haven’t had an opportunity to evaluate your yen holdings, if you have any at all, it might be time to consider a change while the yen is still relatively high. No need to go down with the ship, at least that’s my opinion, for what it’s worth.

Aside from the usual suspects involved with the high yield story, I’ll touch on the big reports from Australia and the UK yesterday. As I mentioned, we were waiting for the results of Australia’s first quarter inflation report to gauge the likelihood of the RBA coming back to the rate hike table sooner rather than later. Well, consumer prices rose the most in five years as the CPI index jumped 1.6% from last quarter while rising 3.3% year-over-year.

While some of this increase can be attributed to higher food prices from the floods a few months ago, core inflation increased more than expected and just highlights the need for vigilance on the part of the RBA. The central bank meets next week so we’ll see if they provide any commentary as to their comfort level regarding these rising figures. With that being said, the Aussie (AUD) broke yet another record by trading up to 1.0879. I even saw a report calling for it to rise into the 1.12 handle within the next six months.

Finally, we had the initial reporting of first quarter GDP out of Britain post a 0.50% gain, which offset the fourth quarter contraction of 0.50% and provided some relief in the markets because there was a real risk of a disappointing figure. It looks as though manufacturing and growth in the service industry gave the needed boost to take them out of negative territory.

Other than that, the euro (EUR) broke into the 1.48 handle and silver got an adrenaline shot that sent it back above $48 as I left for home last night. In fact, it was up over $2.50 as I was turning my screens off last night and it saw an incredible one day swing from its high and low on the day of around $3.50. A strong stomach was definitely needed for silver’s action so far this week. Did I mention gold broke away from $1,500 and moved to a new record high of $1,530?

As I came in this morning, the assault on the dollar continued in overnight trading as the dollar index dipped below 73 and is barely hanging on to that figure as I type. The rand and kiwi (NZD) are the only two at this point in negative territory, so we’ll see what kind of impact today’s data has on the market.

To recap…We finally saw the event that everyone was waiting for, which was Bernanke’s post Fed meeting commentary, and pretty much yielded the expected result. We’re going to see rates on hold for an extended period of time, QE2 will end in June, and the Fed continues to see moderate growth. Durable goods came in better than expected and we now get to see the initial printing of first quarter GDP. The dollar was sold once again across the board except against yen and the real. S&P downgraded Japan’s outlook and Australian inflation remains on the rise.

Mike Meyer
for The Daily Reckoning