The Bank of Canada Sounds Hawkish Again!

Good day… Well… It is me, writing the Pfennig this morning… I jumped the gun yesterday in saying the Chris would pfill in pfor me with the Pfennig. You see, Chris’s daughter, Lauren broke her arm last week, and is going to have to have a pin inserted to make sure it heals correctly… So, rightly so, Chris is with Lauren this morning… And I’m writing from home before I take off to my appointed rounds today.

The currencies got off to a weaker start in this holiday-shortened week after consumer confidence printed even stronger than expected. Overnight we’ve had some stock moves in China that is spooking the markets, and further dollar strength. This consumer confidence thing really gives me a rash, but I carry on despite the dolt mentality of confident consumers.

Never mind that gas prices are going through the roof… Never mind that house prices are falling through the floor… Never mind that the subprime market is gone, and that mortgage rates have risen… What we have here is a failure to communicate! But that’s all I’m going to say on this, because I don’t want to get my blood pressure out of whack!

OK… So the dollar gained on the news throughout the day. Overnight we had a weak industrial production figure from Japan, which was surprising to me… And this has further strengthened the dollar. So… This MAY be the week of the dollar. Personal consumption looks to be stronger when it prints tomorrow, and the “experts” are forecasting a robust 175K new jobs created in the Jobs Jamboree on Friday. So…. If all that plays out, then I expect the dollar to continue to strengthen this week.

But, those are just short term plays… The weak dollar trend is still in place, and this week’s activity is merely just volatility within the trend. Remember, a trend is not a One-Way street! There is volatility all the time, because of weeks like this one. For instance, the euro (EUR) could very well see the underbelly of the 1.34 handle this week… So be careful out there!

The Bank of Canada (BOC) issued a very hawkish statement yesterday that really lit a fire under the already strong loonie (CAD). The BOC really surprised me, in that they hadn’t been very hawkish, leaving rates unchanged for almost a year now. I think that weak kneed stance is going to get them in deep water with regards to fighting inflation. With the economy’s above-trend growth rate suggesting the economy was operating in a deeper state of excess demand producing the risk of upward pressure on inflation. It makes sense to come clean now.

Canada’s core inflation rate rose to 2.5% in April, and while likely to edge down a bit in May, will remain above the Bank’s 2% target in 2007. Therefore I now expect the BOC to begin to raise rates again this year, maybe even as soon as next month. I expect rates to rise 75 BPS this year. So… That’s 25 BPS in three meetings till the end of the year… And if that doesn’t do the trick, papa’s going to buy you a bigger inflation stick!

Yes, don’t be surprised to see rates continue to go higher in 2008! This is all good for the loonie. And with it trading now around 0.9340… It’s already in uncharted waters. So, there’s obviously no problem with it going further in those uncharted waters!

So… The Belle of the Ball in 2006, before the BOC decided that they had raised rates high enough (and I said at that time they were making a mistake) is back in the saddle again.

Yesterday, I talked about how the Indian Central Bank had an ample supply of kryptonite for those traders that thought they had a big “S” on their chests… Meaning that traders were feeling confident moving rupees (INR) higher and higher, and that investment flows into India would be enough to shield the currency from Central Bank intervention to stem the rise.

Well… The Central Bank used some of that kryptonite, and sold rupees overnight, weakening the currency from yesterday’s lofty near nine-year highs. Not to worry. It simply gives us better buying opportunities, eh?

Here’s an “uplifting” note that I saw this morning… 80% of Treasuries due in 3 to 10 years are now owned by foreigners. That’s a record level of foreign ownership. It just goes back to that thought that I first presented to you a couple of years ago… The media does a fine job letting us know what kind of dependence we have on foreign oil… But they fail miserably at letting us know what kind of dependence we have on foreign financing!

But the thing that scares the bejeebers out of me regarding this record amount of Treasuries being held by foreigners is simple: When do they push back from the table and say “enough”… “no mas”… “I’m full”? The Bank of Korea has already announced that they have reached the limit and have no further appetite for Treasuries. Who’s next? (what a great album!) Sure… The Bank of Korea isn’t The Bank of Japan in size, but even the Bank of Japan has gone on a diet of sorts. They used to hold $623 billion in Treasuries, now they hold $612 billion.

Why isn’t anyone else besides little old me worried about this kind of stuff? Maybe I worry too much, eh? But maybe… Just maybe… I’m not the one who’s out on the limb here. Maybe… Just maybe… Everybody else is out on the limb, and when it breaks, it will bring them all crashing to the ground!

As I said above, China saw some stock moves that spooked the markets a bit… The Chinese tripled their transaction tax to discourage the inflow of investors into the Chinese markets. This is the kind of stuff that rippled through the markets in late March, and caused a one-week wonder with the Japanese yen (JPY), as everyone thought the carry trade was being unwound.

I guess the market participants learned their lesson back in March and didn’t hit the panic button this time.

The emerging markets that have seen little if no risk aversion for two months now, had to fall back on their heels a bit. We’ll have to wait and see how this all plays out.

Currencies today: A$ .8155, kiwi .7275, C$ .9345, euro 1.3420, sterling 1.9750, Swiss .8150, ISK 62.15, rand 7.1950, krone 6.0450, SEK 6.9250, forint 187.30, zloty 2.8580, koruna 21.10, yen 121.50, baht 32.80, sing 1.53, HKD 7.8040, INR 40.83, China 7.6470, pesos 10.84, Silver $13.17, and Gold…. $660.90

That’s it for today… Good luck to Lauren Gaffney today! My beautiful bride just brought me a cup of coffee, isn’t she sweet? This reminds me of when I used to be “retired” and wrote from home every morning. I’m seriously thinking of doing this in retirement, but not daily… Maybe twice a week, or something like that. Of course that would have to be a “paid” subscription! Tomorrow, I will talk about energy… And our new energy CD… Until then, have a great Wednesday!

Chuck Butler — May 30, 2007