Summer Days Are Here

Good day… The dollar traded in a tight range yesterday after we got some mixed data from the United States. Today we are data free, so don’t expect any dramatic movements in the currency markets. These summer months usually bring flatter trading patterns in the currency markets as investors and traders head to vacation homes. Without much volatility in the markets, the carry trades are again becoming profitable, so the yen (JPY) saw another drop while some of the higher yielding currencies saw additional buying.

As I mentioned above, the data that was released in the U.S. yesterday failed to give us a clear picture on where this economy is headed. The weekly jobless claims rose for a third week, suggesting the labor market in the United States may be starting to cool. Initial jobless claims rose by 10,000, a third consecutive increase, to 324,000 in the week ending June 16. The four week average, a less volatile measure, rose to 314,500 from 312,000.

In contrast to these poor employment numbers, the Philadelphia Feds factory index jumped to the highest in more than two years in June. The Conference Board’s index of leading indicators, a gauge of the economy’s direction, rose 0.3% in May after a 0.3% drop in the previous month. Both data indicate the U.S. economy may be rebounding after growing last quarter at an annual pace of just 0.6%, the slowest in more than four years. But the Philly Fed index has traditionally been very volatile, and a poor indicator of the direction of the economy. The number gave support to all of those who need to believe the U.S. economy is rebounding. Here is an almost comical quote from one such analyst, Neal Soss who is chief economist at Credit Suisse Group: “The winter blahs for the economy seem to have receded. One of the most reassuring features of the economy has been job growth, and we expect that to persist.” Job growth? I guess he just decided to ignore the jobs report that was released just minutes before.

So the data released yesterday either confirms your beliefs that the economy is heading for a slowdown caused by high energy prices and a slumping U.S. housing market, or you can chose to look on the positive side and say the economy is pulling out of its winter slowdown and headed back into positive territory. As readers know, I am in the camp that is predicting a further slowdown, and one month’s worth of the very volatile Philly Fed index isn’t going to convince me otherwise.

The euro (EUR) was little changed after the release of the German Ifo institute’s business confidence index, which declined more than expected. A rebound in oil prices and higher borrowing costs were the major reasons for the drop in confidence. While the number dropped, it is still high and shouldn’t be labeled as the start of a reversal. Also, with rising fuel prices at least partially to blame, inflation worries continue and expectations for further ECB rate hikes will continue to support the euro. The euro was supported by comments from ECB President Jean-Claude Trichet that suggested he favors increasing rates.

There can be little doubt about Trichet’s feelings regarding inflation. In a speech at a celebration of the Swiss National Bank’s 100th anniversary he had the following to say: “Empirical evidence shows that – since the first half of the nineteenth century, and in a number of countries – fluctuations in trend money growth have almost always led to fluctuations in trend inflation. In light of the evidence coming from the last two centuries of data, totally ignoring trend movements in money growth would therefore entail – in my view – excessive and unreasonable risks. The practice of the SNB and ECB of closely monitoring monetary trends in order to identify long term risks to price stability is therefore validated by the monetary history of the last 200 years.”

And what measure do the ECB and SNB use to gauge inflation? M3, the very same measure that our Fed decided to quit tracking since according to them no one really cared about it anymore. There is little doubt inflation is running too high in the United States, but the FOMC is too worried about the economy to raise rates in order to combat it. It almost seems that the FOMC has just decided that if they can just ignore M3, inflation will not be a problem and there will be no need to increase U.S. rates.

The Swiss government’s economic experts raised their forecasts for growth and inflation this year and next, saying their predictions are based on the central bank continuing to raise their main interest rate. Weakness in the Swiss franc (CHF), due to the carry trade, has bolstered exports. “Switzerland’s robust and broadly anchored economic upswing should continue without any overheating,” the government experts said in today’s statement. According to Swiss central bank President Jean-Pierre Roth, “Switzerland enjoys great prosperity: we are close to full employment, price stability has been maintained for almost 13 years and the economic prospects are favorable in almost all respects.”

The Swiss franc gained today even as the Japanese yen fell, an indication that investors in the carry trade are starting to shy away from using the franc as a funding currency. I expect this reversal of Swiss funded carry trades to continue to occur, and the Swiss franc will play “catch up” to the euro and other currencies, which have been appreciating versus the U.S. dollar. In spite of the low interest rates, I think investors should consider the Swiss franc, for the possible currency appreciation.

The world’s best performing currency this week against the dollar has been the Swedish krona (SEK), which headed for its biggest five-day gain in six years after the central bank raised its benchmark rate and signaled two further increases this year. Other Nordic currencies have also performed well as of late. Norway’s krone (NOK) also strengthened 1.2% against the euro over the past five days, the most since late January. Norway’s central bank will have a policy meeting next week at which they will likely raise rates. These Nordic countries enjoy some of the most stable economies and have had nice currency increases over the past year and half. Look for more good moves by these currencies through the end of 2007.

With the Swiss falling out of favor with carry trade funding, the Japanese yen looks like it has become even more popular. The yen is on course for a second week of losses, falling to a four and a half-year low against the dollar, as investors borrowed Japan’s currency to buy higher yielding assets. New Zealand’s currency seems to be the preferred investment for the carry trade, as the kiwi (NZD) climbed to a 22-year high against the U.S. dollar. As we pointed out last week, New Zealand’s attempt at currency intervention was a futile attempt to fight the currency markets.

With little concern from Japanese officials regarding the weakness of the yen, and volatility easing in the markets, the carry trade will continue to force the Japanese yen down.

Currencies today: A$ .8481, kiwi .7662, C$ .9336, euro 1.3432, sterling 1.9964, Swiss .8105, ISK 62.38, rand 7.1430, krone 5.9486, SEK 6.8877, forint 183.62, zloty 2.8169, koruna 21.3623, yen 124.01, sing 1.5391, HKD 7.8153, INR 40.78, China 7.6239, pesos 10.9118, dollar index 82.55, Silver $13.14, and Gold… $654.05

That’s it for today… I stopped by to see Chuck last night. He is looking good, but is still in some pain. He told me the pain medication makes him tired, so he has been sleeping a lot. Between naps he has been reading and watching a lot of the College World Series. He has also been taking walks with his lovely bride around his neighborhood, increasing the distance with each day. Again, he looks great for what he has been through, and he wanted me to let everyone know he appreciates your support. Hope everyone has a great weekend!!

Chuck Butler — June 22, 2007

The Daily Reckoning