The Day We've All Been Waiting For!

Good day… And a Terrific Tuesday to you! Well… Today is the day… The day we’ve all been waiting for with regard to the Fed Reserve and their decision to cut interest rates or not. You all know that I’ve said for four months now that the Fed would begin to cut rates in the fall…and here we are. The days are crisp, the sun doesn’t pack the punch it did a month ago, the kids are back to school, so it must be fall! (I know, not technically for a few more days!)

And while I said that the Fed would begin to cut rates in the fall back in May, I’m not one of those who believes this is the “end all” for what ails us. First of all, I wish the Fed would concern themselves with fighting inflation, instead of appeasing the markets. In other words… The Fed needs to balance short-term liquidity needs and financial stability with longer run inflation objectives. Second, I just don’t see a rate cut as something that helps us out right now. Sure it helps those mortgage holders with ARMs that are about to reset… But, does a rate cut really help the liquidity/credit crunch in the United States? Does it help in our quest to attract foreign investment to finance the current account deficit? The answer to both of these and many more questions I could come up with, is a big fat NO!

Won’t you just hate to hear Big Ben in a few years give us the Big Al words of wisdom? I mean, Big Al said he knew that the low interest rates were fueling the wild mortgage products, but felt there was nothing he could do. He also stated a few years ago that he saw the tech bubble – there just wasn’t anything he could do about it. So… Fast forward a few years and Big Ben says, “I knew inflation was eating us alive, but we just had to come to the aid of the markets, which was wrong”. I can see that happening… Let’s hope it doesn’t!

The currencies didn’t really move too much on Monday, as the world sits and waits to see what the Fed does and says. Yesterday, I talked about the problems at Northern Rock, and how they had affected the value of pound sterling (GBP). I ended the discussion with a note that I hoped Northern Rock’s problems didn’t become something really bad. Well… Now that one British lender has had to beg for money from the Bank of England to keep their doors open, the markets seem to believe there will be more. I see the reasoning in this thought, due to the fact that these things usually come in bunches.

So, look for pound sterling to remain in a funk for the time being… The weakness could be looked at as a buying opportunity. There may be even more of a buying opportunity as we get closer to the Bank of England’s October rate meeting. If the Bank of England decides to cut rates next month, they are signaling major problems in the pipeline. Even so, rates in the United Kingdom will remain above those offered in the United States and that should underpin sterling going forward.

There are lots of things to worry about as we go through this week that could add to these volatile times. Big Ben makes a trek to Congress to do what used to be called the Humphrey Hawkins testimony. We’ve got the data I talked about yesterday… And then something I don’t talk about very much, because I spend most of my waking hours researching, reading, and analyzing economies and currencies, but that is corporate profits… Namely, bank earnings and those performing mortgage operations, such as Lehman Bros., Morgan Stanley, Bear Stearns, and Goldman Sachs all report this week.

The reason I bring this up was the announcement by Merrill Lynch, which warned on Friday that subprime issues continued to represent a risk to their operations.

Speaking of subprime issues… Did you see the interview with this guy named Kal Das, who happens to be a banking attorney specializing in the mortgage industry? Mr. Das, said, “the carnage is far from over.” OUCH! Any time someone uses the word “carnage”, that’s ugly!

This morning we’ll see what PPI looks like for August, and the all important TIC’s report, which tracks the investment flows into and out of the United States. I’m going to spend a minute talking about the TIC’s report… One might think right away that August was so wild and wooly that a drop in foreign purchases would be the norm. Unfortunately, we’re going to see July’s report this month. (By the way, you can’t tell me that this data can’t be more timely!)

We’ve backed ourselves into a dark corner with the size of our current account deficit, and the requirement of over $2 billion per day in foreign investment to finance the deficit. And the overall trend for this data has been sliding each month. It used to be the argument of those dollar bulls and the people who don’t believe that deficits matter, that all’s well as long as we attract financing. But with the amount of investment flows coming in smaller each month, we’ll soon be at the level below the $70-$75 billion needed on a monthly basis.

When that happens, there are two things the government can do… 1. Rate rates to attract investment. Or 2. Allow the currency to be debased. With regard to number one… We all know the Fed is going to begin cutting rates today, so throw that one out the window… And number two… This would be the government’s choice anyway… So, watch for further weakness in the dollar…

Oh, and one more thing… It was August that the Chinese mentioned their “nuclear option” of selling treasuries. So… If July’s balance shows further weakening, August’s balance should be quite ugly. And that means… Further currency debasing, which will come in the way of rate cuts. Which, by the way, I not only said in May while talking to a group of people in Panama, that the Fed would begin to cut rates in the Fall, but followed that up with a call for additional rate cuts in October, and December. And all that plays well with the currency debasing that will be needed to attract foreign investment to finance the current account deficit!

Geez Louise… Just when you thought it was safe to fill up your gas tank with profit taking going on in the oil market… Along comes another wave of bidding up oil to not only push it past $80 once more, but move all the way to $81 in the Asian markets overnight! WOW! And UGH! Someone put out a message that said something to the effect that the Fed rate cut would give a booster shot to the economy, and get people spending money on gas again, thus driving up the demand… I don’t know about that, but oil sure responded!

I know a guy that’s an oil man… And every time I see him he’s smiling like a Cheshire Cat… I bet that smile goes ear to ear now!

Gold experienced another strong performance yesterday moving up $6 on the day to $723.80. And why not? Deposit rates are going to come down in the United States, and in my opinion the lower rates will only fuel inflation even higher. And haven’t I told you time and again that historically, it is proven that gold acts as an excellent hedge against inflation?!

Chris Gaffney reminded me yesterday that I’ve never announced our latest addition to the currency roster… One that people had beat on us to add for years now… Brazil real (BRL). We did a nice write up on Brazil in the latest Review & Focus that goes to print in a few days to be delivered to your doorstep the first week of October. But If you can’t wait until then, call our trading desk and they will tell you all about the requirements and features of the new Brazilian real CD! The trading desk number (which has been the same for over 20 years now) is 1-800-926-4922.

The subprime worries in the United States have spilled over to Germany as witnessed by the German investor confidence, as measured by the think tank ZEW, which fell for the second month in a row. The fall was larger than expected too! So… The once proud tub-thumping German economic recovery may be seeing chinks in the armor… But, that’s not going to stop the euro (EUR), my friends. It may stop the ECB from further rate hikes, but with rates remaining steady Eddie, and U.S. rates falling, the euro should not have any trouble gaining versus the dollar, even in the face of a weakening German economy.

And someone mentioned to me yesterday that I hadn’t really talked about the Japanese yen (JPY) much lately. Hmmmm… I really didn’t remember it that way, but if they say I didn’t… There’s probably a chance I didn’t! Come to think of it… Why would I talk about Japan? Nothing is happening there except the choosing of a new PM… Yen is probably going to remain in the current trading pattern until RISK returns to the marketplace. Right now, market participants have forgotten the pain of the last bout of risk aversion. The Northern Rock situation could have pushed the markets to risk aversion, which would have boosted the yen… But, the Bank of England stepped in to put that fire out quickly.

So… When risk returns to the marketplace, which will unwind carry trades, we’ll finally see yen strength… But don’t ask for risk to return… That situation in August was downright scary!

Currencies today: A$ .8345, kiwi .7045, C$ .9740, euro 1.3870, sterling 1.9940, Swiss .8430, ISK 64.90, rand 7.2110, krone 5.6175, SEK 6.7010, forint 183.75, zloty 2.7290, koruna 19.83, yen 115, baht 31.90, sing 1.5160, HKD 7.79, INR 40.50, China 7.5260, pesos 11.13, dollar index 70.71, Silver $13 and Gold… $726.80 (still moving higher!)

That’s it for today… Yesterday I told you about the Casey Research Crisis & Opportunity Summit that the Big Boss, Frank Trotter will be speaking. Today, I will tell you about the International Living Ultimate Event taking place in Panama. At the same time Frank is in Denver, I will be in New Orleans, and Chris Gaffney will be in Panama. I’ve been to Panama twice in the past year and one half, so it was time someone else went!

A long day yesterday… I was totally wiped out when I got home, but still had to write the Review & Focus, so no napping for me! UGH! Today should be better… And next Monday, our Jennifer returns from maternity leave… YIPPEE! Got to hit the send button now… Have a Terrific Tuesday!

Chuck Butler — September 18, 2007

The Daily Reckoning