The Newest Pfennig Reader

Good day… I’ll let Chuck start the Pfennig off this morning with his big announcement:

“Yes, folks… I am a Grandpa! My darling daughter, Dawn, gave birth to another darling girl. Delaney Grace McCoy came into our lives late Saturday night; mom, baby and dad are all doing well… Tired… But well.

“OK, now onto the markets… Proving that even a blind squirrel can find an acorn… I thought that the Jobs Jamboree would be disappointing and cause the dollar to be taken to the woodshed on Friday… And that’s exactly what happened!

“The euro (EUR) saw a lot of pent up frustration trading take place, and vaulted to a healthy 1.38 and change. In the Asian market Sunday night, I saw profit taking, although right now the euro is remaining above 1.38.

“The yen (JPY) has reached a four-month high versus the dollar… So it’s not all about the euro!

“The BIG NEWS this week is the Fed’s FOMC meeting tomorrow. I don’t expect any rate moves, and I don’t expect Big Ben Bernanke to alter his somewhat hawkish stance… And his claim that the economy will weather the mortgage meltdown storm, and growth will remain what he calls ‘moderate.’

“There are more credit issues every day with regards to the mortgage meltdown/sub prime mess… And these are playing dangerous games with stocks… And the dollar!”

Chuck called it right Friday, and the disappointing jobs data let the dollar index slide all the way to 80. This morning, in European trading, the dollar index moved down to 79.96 before moving back up to trade just above 80 this morning. Without any data due out today, the markets will be waiting on the FOMC announcement tomorrow. No rate change is expected, but it will be interesting to see how Bernanke handles the latest squall in financial markets.

Four months ago, when we had a miniature version of what has occurred here the past two weeks, Bernanke and his colleagues made slight changes to the wording of their rate announcement. But rhetoric won’t rescue the U.S. dollar this time, and unless he makes a suggestion that they are getting very worried about the subprime mess, look for the dollar to continue to slide.

I was at a party this weekend, and struck up a conversation with a local money manager who I’ve known for a number of years. He is convinced the Fed will be “rescuing” the markets with a cut in rates either tomorrow or at the next FOMC meeting. When I disagreed and gave inflation as my reason, he countered with, “What inflation?” I brought up the obvious answers of food and energy, to which he pointed out “food makes up just 12% of GDP, and energy prices are falling again.” I then brought up the growth of M3, to which he said “nobody looks at M3 anymore, it’s the core inflation data which drives the markets.”

This illustrates just how powerful the Fed can be without even touching interest rates. Here is a smart guy (he is a fellow CFA) who is in charge of a substantial amount of money and has bought into the Fed’s rhetoric hook line and sinker. The Fed uses the power of the media to direct the views of investors, and Bernanke will make another attempt at steering the flow of capital tomorrow. I expect him to give a little something to everyone. He will sound hawkish on inflation, keeping a steady hand on rates; but will also point out the risks to the economic growth that the mortgage mess has caused. In the end, there will be no movement in rates, and investors will be able to spin the accompanying message to suit their own needs. But the key to our readers is what will happen to the currency markets.

My talk with the money manager has further convinced me the dollar will continue on its long-term slide. While I don’t believe the Fed will be able to cut rates this year, my friend has convinced me that recent events have leaned the Fed back toward a cut. Fed Fund futures show traders see an 84% chance the Fed will cut its 5.25% benchmark rate by October. The odds were just 14% a month ago. So if I am wrong, and the Fed does make a move, it will likely be down, which will further narrow the interest rate differential the United States has enjoyed over most of Europe and Asia. Without these higher interest rates, the dollar will be in even bigger trouble.

I finally saw a story on the rise of the Japanese yen that didn’t give credit to the reversal of the carry trade. Japan’s broadest indicator of the outlook for growth signaled for the first time in eight months that the economy will expand. The leading index climbed to 80% in June, the first time it has been over 50 since October. Industrial output rose 1.2% in June, ending the worst slump in two years, and companies have indicated they expect production to increase more in coming months. But this improved outlook for growth still doesn’t guarantee an aggressive move by the BOJ at their next meeting.

While BOJ Governor Fukui said last month that prices will “definitely” increase in the long term and the bank should raise its key interest rate from 0.5%; those in Japan’s cabinet office don’t believe we have seen the end of deflation and are encouraging the BOJ to wait on increasing rates. Economic and Fiscal Policy Minister Hiroko Ota said, “The end of deflation has been delayed, wage growth has been slow and oil prices haven’t spread to consumer prices.” It will be interesting to see which of these two powerful forces wins out with regard to Japanese interest rates.

The euro had a good weekend versus the dollar and is again trading above 1.38 this morning. German factory orders unexpectedly surged the most in more than two years in June, driven by sales to other euro-region countries. Orders, adjusted for seasonal swings and inflation, jumped 4.6% from May, when they increased 3%. This is the biggest gain since 2004 and illustrates the overall health of the European economies.

Manufacturers are buying new equipment, which will continue to improve capacity and efficiency, helping the recovery that is already well under way. The economy of the 13 nations using the euro is expanding at the fastest pace since the turn of the decade, as global demand for European goods prompts companies to expand capacity and hire more staff. The IMF last week raised its forecast for growth in Germany, citing “great strength” in exports and investments. Look for the euro to continue to march back toward $1.40 and beyond.

Another of our favorites, the Swedish krona (SEK), was among the best performing major currencies on speculation the central bank will raise rates to curb inflation. A report last week showed that the economy grew faster than expected in the second quarter and the Riksbank has said it may lift rates twice more this year. Gross domestic product growth quickened to an annual 3.6% in the second quarter from 3% in the first. Both the Swedish krona and Norwegian krone (NOK) will continue to increase versus the U.S. dollar on both strong economic fundamentals, and increasing interest rates.

Another currency that has had a terrific performance over the last month is the Swiss franc (CHF), which rose to its highest level in more than two years overnight. Most of this latest move has been due to a reversal of the carry trades, as investors sold riskier assets, such as equities, and repaid loans taken out in the Swiss currency. The Swiss franc has broken through some key support levels, and looks set to continue its rapid assault on the dollar.

Gold in Asia was little changed near a one-week high, supported by investors demand for the precious metal as an alternative asset. Silver rose on increased demand and investor moves out of riskier assets. I read a story on Bloomberg this morning where the Vice Chairman of Newmont Mining Corp predicts gold will surge to more than $1,000 per ounce. He said increased jewelry demand and a weaker dollar will drive the price of gold up. While I’m always cautious about reading predictions from individuals who have so much to profit if they come to fruition, he did make some good points. The supply of gold from mines is dropping as companies fail to make major discoveries and licensing issues slow down construction. Gold jewelry demand is expected to rise from an increase in global wealth. Jewelry accounted for two-thirds of gold demand in the first quarter.

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Currencies today: A$ .8571, kiwi .7620, C$ .9483, euro 1.3816, sterling 2.0307, Swiss .8429, ISK 63.74, rand 7.1045, krone 5.7536, SEK 6.6780, forint 181.65, zloty 2.7418, koruna 20.31, yen 117.87, sing 1.5150, HKD 7.8291, INR 40.42, China 7.5610, pesos 10.991, dollar index 80.18, Silver $13.11, and Gold… $674.34

That’s it for today… Welcome to our world little Miss Delaney Grace McCoy!! It was great to hear Dawn and the baby are doing fine. I’m sure Chuck and Kathy will be showing off pictures of their first Grandbaby at the ball game this Friday. All of the office is going down to Busch stadium on Friday to watch our beloved Cardinals. Just hope it cools off a little, as the heat index was well over 100 degrees all weekend! Have a great start to your week, Happy Monday

Chris Gaffney
August 6, 2007

The Daily Reckoning