Terror Threat

Good day. The British announced they uncovered a plot to blow up 10 trans-Atlantic flights, and the United States raised its threat level. I’m certain everyone will be inundated with information regarding the foiled plot, so I will just try and let you know how it has affected the currencies. Both the U.S. dollar and the pound sterling sold off as the announcements came out.

U.S. traders often sell the dollar during terrorist incidents, as the United States is usually one of the targets. The Swiss franc, typically seen as a safe haven, climbed the most in a week against the U.S. dollar before giving up its gains. The pound sterling fell the most in three weeks as British Airways canceled all incoming flights to Heathrow airport. It is possible that we will see more selling of the pound if the news keeps escalating. This sell off of pound sterling was not dramatic and will no doubt be short lived. If you have been kicking yourself for not having some exposure to the pound, this may be an excellent opportunity to pick some up a little cheaper. We can just be thankful that the plot was discovered! While there was some initial panic immediately after the announcement, traders will quickly return to the data due out later today.

The U.S. trade deficit probably widened to $64.5 billion from $63.8 billion in May. The gap set a record back in October when it hit $66.6 billion. This trade gap will likely cause a further sell off of the dollar as we are on track to top last year’s record $716.7 billion deficit, which was 5.8% of U.S. GDP. In another report due out later today, the United States budget deficit is expected to have narrowed to $40 billion last month from $53.4 billion in July 2005. Finally, the weekly jobs data, due out at the same time as the trade deficit, is expected to be unchanged from last week’s numbers. So, this morning’s data should sell the dollar off with the afternoon data possibly stemming the slide.

After the trade gap is announced, we will likely be hearing U.S. lawmakers shouting for a change in policy toward China. In a preemptive strike, China’s central bank today reiterated that it aims to withdraw from the country’s currency market and make conversion of the renminbi into foreign exchange easier for trade in goods and services.  It said yesterday that it would allow the yuan to rise faster to help cool export growth that pushed its trade surplus to an all-time high for a third month. As we have been pointing out in the Pfennig and our monthly Review & Focus, trade surpluses should lead toward a stronger currency. Since China has been limiting the appreciation of the renminbi, upward pressures continue to grow. Other Asian currencies have begun to let their currencies appreciate with Singapore and Thailand leading the way.

Singapore’s economy grew for a fifth quarter, the longest expansion in more than five years. Southeast Asia’s fourth-largest economy grew at an annual three-percent pace in the second quarter according to a report released today. That is almost three times the government’s July estimate. While you can’t get any yield buying the Singapore dollar by itself, it is part of our two Asian Index CDs, the Asian Advantage and our new Orient Opportunity. Both of these indexes have the two top-performing Asian currencies, the Thai baht and the Singapore dollar. I would encourage readers who are holding Japanese yen or Singapore dollars to take advantage of these index CDs, as they are an excellent way to get some yield from their Asian holdings.

The Japanese yen may see some strength today as a report showed that in July, Japan’s producer prices rose at the fastest pace in a quarter of a century. With a growing economy and increasing price pressures, the Bank of Japan will have to consider raising rates again in 2006. This should be supportive of the Yen.

The European central bank said it plans to raise interest rates further to contain inflation if the economies of the dozen euro nations develop as it expects. The bank is concerned inflation will accelerate as economic growth picks up and workers demand higher wages to compensate for surging energy costs. “In the second half of 2006 and on average in 2007, inflation rates are likely to remain above 2 percent,” the ECB said in today’s report.  The narrowing of the interest-rate gap, which the United States has had over the euro will certainly cause an appreciation of the euro. We continue to call for the euro to trade above 1.30 by year’s end (we may have to adjust that call as the Euro has traded 1.29+ a few times already).

And finally, the commodity currencies of Australia and New Zealand dollars surged to their highest levels in at least two months, after government reports today showed their respective unemployment rates unexpectedly dropped to records. Jobs growth at more than 10 times forecasts boosted demand for the currencies as traders predicted interest rates in Australia and New Zealand would stay higher than in the United States for a longer period. We still believe Australia will probably look to raise rates again this year, and the markets no longer think Reserve Bank of New Zealand Governor Bollard will look to lower rates in New Zealand.  While both will continue to perform well, we still feel the Aussie dollar will trend up faster than the kiwi.

Currencies today: A$ .7693, kiwi .6340, C$ .8932, euro 1.2861, sterling 1.9035, Swiss .8154, ISK 70.61, rand 6.7675, krone 6.179, SEK 7.14, forint 210.28, zloty 3.01, koruna 21.80, yen 114.85, baht 37.42, sing 1.5692, INR 46.42, China 7.971, pesos 10.87, dollar index 84.70, silver $12.49, and gold $650.80

That’s it for today. Again, great work by the British to uncover the terrorist plot. I still feel sorry for anyone having to get on a plane today, looks like the lines are long! Hope everyone has a great Thursday.

Chris Gaffney
August 10, 2006

The Daily Reckoning