The Loonie is Hot

Good day… The dollar held onto last week’s gains over the weekend as investors continued to remain in a defensive cash position. We don’t have any data being released in the United States this morning, so expect the range trading we have seen overnight to continue. But we have a plethora of data releases over the remainder of the week, so we will likely see the dollar move back into its longer-term trend.

Chuck is still at home fighting an infection in his hip, but he forwarded the following to me last night:

“Well… Sitting here looking at the news stories, I can’t help myself but to keep looking for stories on Canada. The Canadian economy and fundamentals have really been hot recently, and that has pushed the loonie (CAD) higher and higher. Friday, we had the Canadian Trade Report give the loonie more fuel by showing the April trade surplus, that’s right I said surplus, widen more than expected.

“Canada’s trade surplus rose more than expected to $5.8 billion from an upwardly revised $5.1 billion in March. A large part of this printed surplus was due to slower imports. While that might raise some eyebrows of those thinking that means the economy will slow down, a look at the fact that imports are up 4.5% in the first quarter will make those thoughts go away.

“I’m sticking to my story that I wrote about recently that the Bank of Canada (BOC) will raise rates three times to the end of the year, and two more times in 2008. And that should push the loonie higher.

“Moving on… The U.S. trade deficit narrowed in April to $58.5 billion from March’s $62.4 billion posting. In the United States, the trade deficit benefited from a slowing import number. I just talked about Canada’s lower import number not being a worry, but in the United States I think it IS a worry. Slower spending by consumers leads to the lower imports. Slower spending leads to an economic slow down.

“The other thing to think about here is what I’ve preached about for a decade now. The U.S. dollar was overvalued, and too expensive to make our exports competitive. So, think about this… The dollar is much weaker, and our exports rise. A coninquidink? I don’t think so!

“Treasury yields are really moving higher and that has attracted foreign investors to the U.S. bond markets, thus supporting the dollar. I don’t think the mortgage guys like to see these Treasury yields going higher, do you? This isn’t going to help the mortgage meltdown going on right now.”

Thanks to Chuck for those thoughts on the loonie and last Friday’s trade numbers. The top story over the weekend was China’s trade surplus which rose a bigger than expected 73% in May from a year earlier. So while the U.S. deficit narrowed, China’s surplus continues to grow. As we have said in the past, a slowdown in the United States won’t bring China to a halt. In fact, the European and Asian consumers seem to be picking up the slack.

Chinese government officials will have to continue to look for ways to slow their economy. Pressure will be increased on the Chinese for an acceleration in the gains of the renminbi (CNY). A stronger renminbi would ease tensions with trading partners and help prevent the world’s fastest growing major economy from overheating.

With China’s economy continuing to run on all cylinders, the commodity driven currencies of Australia and Canada continue to hold their value. The New Zealand dollar (NZD) had also moved up dramatically, but dropped almost a cent overnight after the central bank sold its currency following Friday’s rally. NZD central bank leader Bollard said in a statement the bank “acted in the market because exchange rates are exceptional and unjustified in terms of the economic fundamentals.” I have been watching the currency markets long enough to know that central bank intervention is a dangerous game. While the bank may be able to move the currency in the short term, very few central banks have deep enough pockets to counter the markets and keep the currency moving upstream. New Zealand’s central bank doesn’t have the capital to fight the markets, and unfortunately I think this most recent intervention will end up being a waste of reserves.

But maybe Bollard was simply trying to send a message to the markets and to start putting the squeeze on some of the “carry trade” investors. This carry trade has sent an enormous amount of money into the higher yielding currencies of New Zealand and Iceland. Both of these benefactors of the carry trade would love to see some of these investments leave, releasing the inflationary pressures they have brought with them. This intervention by Bollard, therefore, is most likely an attempt to let the markets know that the NZD central bank will not just sit back and continue to watch the carry trade flood their economy with capital. But as I said before, the market is much bigger than any one central bank, so this move is nothing more than “sending a message.”

Speaking of the carry trade, the Japanese yen (JPY) rallied a bit over the weekend as reports showed that the economy expanded more than expected in the first quarter. The world’s second-largest economy grew at an annual 3.3% rate in the three months ended March 31. Reports last week showed machinery orders rose for the first time in three months in April signaling business investment will probably keep driving the expansion.

These reports show the Japanese economy is very solid, and may persuade the Bank of Japan to raise its interest rates as early as next month. We believe Japan should have already moved on interest rates, as their delay has only increased the probability of a dramatic move by the yen once the BOJ does move. The longer the BOJ waits, the greater the chance that external forces lead to a sudden, sharper rebound that might cripple Japan’s economy.

As I mentioned above, today and tomorrow we will likely see range trading with not the only data release being Tuesday’s monthly budget statement (no surprises here, just a bigger deficit number!) and ABC consumer confidence. Wednesday we will get Import price data along with advance retail sales, business inventories, and the Fed’s beige book. Thursday will bring us PPI data along with the weekly jobs numbers. Friday will end our week with a very busy data day as we will see the important CPI data for the month of May along with the empire manufacturing, current account balance, the TIC flows for April, industrial production, capacity utilization, and finally the U. of Michigan confidence number. So while the start of the week will be slow, we will get slammed with data on Friday!

Currencies today: A$ .8425, kiwi .7502, C$ .9418, euro 1.3342, sterling 1.9670, Swiss .8017, ISK 63.89, rand 7.2627, krone 6.085, SEK 6.998, forint 190.38, zloty 2.8754, koruna 21.33, yen 121.74, sing 1.5439, HKD 7.8138, INR 40.82, China 7.6642, pesos 10.9338, dollar index 82.78, Silver $13.16, and Gold… $651.35

That’s it for today… We took my wife’s parents to the new Busch Stadium for the first time Saturday night to watch the Cardinals play the Angels. Unfortunately the Angels beat up on our pitching, but we had a beautiful night and I had a foul ball bounce off my hand. I just wish I would have listened to my son and had brought my glove! Hope everyone has a great start to their week. Happy Monday!!

Chuck Butler — June 11, 2007

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