Subprime Woes Go Global

Good day… Without any data in the United States and a slow data day in Europe, the currency markets continued to track along their recent trend lines which are dollar negative. The mood of the markets continues to be one of trepidation as traders wait to see just what the subprime mortgage mess will bring next. Traders continue to come to the realization that the U.S. housing slowdown and subprime mortgage mess will not go away quickly.

Data due out today and tomorrow will do little to calm their fears. The ABC consumer confidence number and Richmond Fed Manufacturing index are the only two reports that will print today, and neither is expected to show much strength. Tomorrow we get a snapshot of the housing market with the release of MBA mortgage applications and existing home sales in the morning, followed by the release of the Fed’s beige book in the afternoon. Existing home sales will be the driver of the markets and are expected to show a month on month drop of 2.1% in June.

With the markets nervous about this week’s housing reports, the dollar weakened against all of the 109 most active currencies. Even the Japanese yen (JPY) got in on the fun as it strengthened to a two month high versus the greenback. The dollar’s slide accelerated after the dollar reached levels that triggered automatic sell orders.

News released yesterday shows that the subprime rout is going global, as Reuters reported that Basis Capital Fund Management Ltd., an Australian hedge fund, is hiring Blackstone Group LP to advise the fund on limiting its losses. It seems Basis Capital Fund bought into the CDO markets; and these investments are falling fast. I also read that Japan’s nine biggest banking groups have more than 1 trillion yen of combined holdings in products backed by U.S. subprime mortgages.

This is an interesting twist to the mortgage mess, as foreign investors are starting to feel the pain. These foreign investors have been pouring money into the U.S. markets, supporting our deficits and keeping our dollar strong. We have been talking about how these foreign investors will start moving away from their U.S. investments on interest rate differentials, and this latest report of subprime losses will only serve to accelerate these sales.

In the category of “what is he smoking”; U.S. Treasury Secretary Henry Paulson was on CNBC yesterday and said that problems in the subprime mortgage loan sector could be contained and would not hurt the overall economy. I think Mr. Paulson should try and tell that to investors in his former firm’s hedge funds! Confirming our assertion that the Treasury Secretary must have been on something, he followed up his subprime comments with a statement that a strong dollar was in the best interest of the United States. Tell that to the manufacturers who are trying to compete with Asia!

Dollar losses versus the euro (EUR) were limited as offsetting economic reports released this morning made it difficult for traders to establish a direction in early trading. The conflicting data started on the consumer side as French consumer spending surprised to the upside rising 1.6% from the 0.7% that was expected. This was the best reading since August 2006 and was buoyed by a sharp reduction in French unemployment. On the other hand, Italian retail sales showed a far more tepid rise of just 0.1% versus the 0.3% that was projected.

Other data this morning showed that growth in Europe’s manufacturing and service industries slowed more than economists expected in July. The Royal Bank of Scotland Group Plc’s combined index fell to 57.3 from 57.8 in June as reported by Reuters. While this index did fall, any reading above 50 indicates expansion.

This negative data was offset by German import prices, which increased more than economists expected in June. German prices rose 1.3% in the year, the biggest gain since December of 2006. These price gains will continue to put upward pressure on the euro.

The pound sterling (GBP) rose to the highest in 26 years against the dollar on further speculation that the BOE will raise interest rates at least once more this year. Much of this recent movement in the pound is due to momentum as data released today should have been somewhat negative for sterling. British factory orders unexpectedly fell in July, but currency traders largely ignored this data and continued to make bets that the pound will rise. The BOE will meet next on August second, but will probably wait until September to make their next move up.

Two other currencies that have been benefiting from interest rate differentials are the New Zealand (NZD) and Australian dollars (AUD). The New Zealand dollar moved over 0.81 cents for the first time last night before moving back down in early European trading. The Australian dollar also continued to gain and hit a new 18-year high. Both currencies continue to benefit from some of the highest interest rates in the industrialized world. The New Zealand central bank is expected to boost its key rate a quarter of a point this week. New Zealand’s dollar will extend its rally to 83 cents, said John Key, the leader of the nation’s opposition party and former European head of global foreign exchange at Merrill Lynch.

The Aussie dollar gained yesterday after a government report showed that producer prices rose by more than economists expected in the second quarter. A report tomorrow is expected to show Australian inflation accelerated last month. Australia’s consumer price index probably gained 1% in the second quarter compared with 0.1% in the first three months of the year. These higher inflation numbers will continue to push the Reserve Bank of Australia into raising its overnight cash rate at their next meeting on August 8.

In preparation for my presentation later this week at the San Francisco Money Show, I ran a spreadsheet calculating the currency returns for all of our different index CDs. I was happy to see that all of these indexes had returned over 9% annualized on a year-to-date basis. The Commodity Index was the top performer with a currency only return of 9.63% during the first seven months. Our new WorldEnergy Index was second with a currency return of 9.29% and the Prudent Central Bank was number three at 8.54% so far in 2007. Even more impressive are the total returns (including interest) for these Index CDs. The Commodity Index was still the top at 14.38%, followed by the WorldEnergy at 13.61% and then the Prudent Central Bank at 12.09%. GREAT STUFF!!

Currencies today: A$ .8847, kiwi .8082, C$ .9565, euro 1.3812, sterling 2.0602, Swiss .8298, ISK 59.15, rand 6.8237, krone 5.7313, SEK 6.6390, forint 178.15, zloty 2.7226, koruna 20.4079, yen 120.80, sing 1.5059, HKD 7.8217, INR 40.2325, China 7.5685, pesos 10.7742, dollar index 80.22, Silver $13.335, and Gold… $682.97

That’s it for today… We are back at full staff this morning, so it should be a better day on the desk. The big boss Frank Trotter emailed me from Vancouver last night where he is one of the key speakers at the Agora Financial Investment Symposium. He is expecting some great crowds out there. I still have to finish the presentation for San Francisco, so got to get to work! Hope everyone has a great Tuesday.

Chuck Butler — July 24, 2007