The Game Continues

Good day… As Chuck mentioned on Friday, he is on his end-of-year vacation, so I get to bring you the Pfennig this week. Yesterday morning I came by the office early to catch up on the markets and was amazed to see another line wrapping around our building. It seems that Best Buy, which is located on the first floor, was getting a shipment of WII and Nintendo DS games. These games may be great entertainment, but I’m afraid we are going to be losers in the world’s economic game. Does it scare anyone else that we have lines of U.S. consumers fighting to spend their borrowed money on goods made in Asia? On that cheery note, lets get to the currency markets.

The dollar has continued to rally over the weekend, with the dollar index moving back above 84 for a while in early European trading. We believe this sell off in the currencies was healthy for the market, as the dollar had slipped too far, too fast. Look to the current levels as excellent end of year buying opportunities for those of you who have failed to get diversified out of the dollar.

The big news Friday that pushed the dollar higher was the Net Foreign Security Purchases (NFSP) for October, which jumped up to 82.3 billion. So international investors have boosted purchases of U.S. securities in October, which will help finance all of the holiday shopping in the United States. It will be no surprise to Pfennig readers that those who were responsible for the biggest percentage gain in holdings were the foreign central banks!

Yes China, Japan, and the other Asian Central banks boosted holdings of U.S. securities by the most in almost two years during the month of October. These purchases of U.S. debt by the central banks have a dual impact on the U.S. economy. First, it allows them to sell their own currency and buy dollars, keeping the dollar strong and their currencies weak so prices of their products remain low to U.S. consumers. Second, the purchase of U.S. debt has kept our interest rates down, keeping the ‘borrow and spend’ U.S. consumer happy. It scares me to think just how easily these countries have led the United States down this path of destruction. But you can’t really blame them; they are just trying to do what’s best for their own exporting economies.

Other data released on Friday showed that consumer prices were unchanged, which surprised economists who projected an increase, and reassured Federal Reserve policy makers that inflation will be held in check. Interest rate futures now show that traders see an increased chance that the FOMC will lower rates in March ’07. Falling interest rates in the United States will not be good for the dollar, but the NFSP overshadowed this inflation data and the dollar was able to rally.

So the game continues. The manufacturing economies of Asia continue to produce and ship goods to the United States, which U.S. consumers eagerly wait in line to purchase on credit, which is financed by the Asian central banks. Today we will get to see just how wide the U.S. current account deficit has become. The CAD is expected to have widened to a record $225.5 billion during the third quarter, from a gap of $218.4 billion in the prior three months. As regular readers know, we believe this deficit is going to be one of the main forces moving the dollar lower in coming years.

On Friday, our corporate currency specialist, Ashish Advani, shared some views on the Canadian dollar that I thought were very interesting. It seems a pattern has emerged in the trading of the loonie versus the U.S. dollar:

Between September 26, ’06 and October 17, ’06, USD/CAD rallied from 1.1087 to 1.1419 (332 bps, 14 trading days). The Pullback – 240 bps to 1.1179 on October 27, ’06 (eight trading days).

Between October 27, ’06 and November 21, ’06, USD/CAD rallied from 1.1179 to 1.1496 (317 bps, 17 trading days). The Pullback – 209 bps to 1.1287 on November 28 ’06 (six trading days).

And the most recent up leg…

Between November 28, ’06 and today, USD/CAD rallied from 1.1287 to 1.1580 (293 bps so far and 12 trading days).

Another day or two of topside pressure, and 24-39 bps would put USD/CAD around 1.1604/19, which is almost exactly the top of a six-month-old ascending price channel. It would also match the previous two up legs in both magnitude and duration (and time of month for that matter). SHOULD the pattern repeat itself, we could see a 200-250 bps pullback to unfold sometime over the next week and possibly over the illiquid holiday week after that. Target would be ~ 1.1350, which is where the daily support line that connects the pullback lows mentioned above comes in. Good news for the Canadian dollar.

The Bank of Japan will probably refrain from raising interest rates – the lowest among major economies – until January, as it gathers more data on consumer spending and examines the strength of the global economy. Governor Fukui’s policy board will keep the key rate at 0.25% when it concludes a meeting tomorrow, according to a majority of economists. The latest Tankan quarterly survey, Japan’s most closely watched gauge of business sentiment, showed that confidence among large manufacturers climbed, but not enough to facilitate an increase by the BOJ this month. The Japanese economy is accelerating, but the government will want to see more data prior to increasing rates.

Finally, Paulson and Bernanke are flying back to the United States after wasting time in China. As expected, the Chinese leadership has assured this dynamic duo that they will be easing restrictions on the renminbi, letting it freely float at an unspecified time in the future. In exchange, Paulson said he would work on increasing the savings rate in the United States. So we have more of the same – an assurance of flexibility with no timetable. Look for the renminbi to continue to slowly appreciate versus the U.S. dollar.

Currencies today: A$ .7817, kiwi .6900, C$ .8653, euro 1.3098, sterling 1.9500, Swiss .8192, ISK 68.59, rand 7.0138, krone 6.2173, SEK 6.9145, forint 193.17, zloty 2.8983, koruna 21.14, yen 117.76, baht 35.95, sing 1.5446, HKD 7.7744, INR 44.735, China 7.8202, pesos 10.7675, dollar index 83.96, Silver $12.965, and Gold… $617.15

That’s it for today… Only a week left until Christmas! The Rams received an early Christmas gift as they got to beat up on the lowly Oakland Raiders this weekend. Oh well, we will take the wins which are given to us. Hope everyone has a great week!!

Chris Gaffney
December 18, 2006

The Daily Reckoning