This is Not a Trend Reversal

Good day… And a Terrific Tuesday to you! And also, welcome to April! We have a wonderful young lady in the office that is our IRA specialist, named April… I call her April Showers, she always giggles… It’s her month!

You know the old saying about April showers bringing May flowers, and what do May flowers bring? Pilgrims! HA! Anyway… Happy April to everyone, hopefully the rain will stop here and the sun will come out, and we can get on with spring!

Opening Day was rained out in the third inning with the home team Cardinals up 5-1… Those are 5 wasted runs, as they all get washed out and we have a “do over”.

Yesterday, I left you with the news that the euro (EUR) had ventured above 1.58 again. By the time I got to work, (I arrived late because I had to deal with a sick car) the euro had risen to 1.5889. WOW! But, by the time I got through all the mail on my desk, the euro had given up that rally and profit taking began once again, driving the currency to 1.5815… And then even lower as the day went on.

Overnight, the euro lost even more ground and fell through the 1.57 handle… German retail sales unexpectedly declined in February, and had the biggest drop in almost a year… Seems the 3.5% inflation I told you about yesterday is beginning to eat away at people’s wallets. Retail sales fell 1.6% in February from January, and really put the heat on the ECB to cut interest rates.

There was some good news from Germany overnight, which was largely overlooked by the currency traders. German unemployment has reached its lowest level in 15.5 years! The March report showed hiring across many sectors… 1992 was the last time unemployment was less than 8%… Good show!

Remember… I told you time and again in the past that the euro would get dented when the ECB does finally cut rates, which I believe will come next month… I also said that it would be a short-term thing… Remember? It was when the euro was about 1.45, and I said it could go down to 1.40. Well… Now it has seen the light of 1.58, I certainly don’t believe it will fall all the way to 1.40 any longer! So… The markets may be pricing in a rate cut before its time, which means they aren’t going to wait for May… Which also means we could see the euro get dented ahead of the rate cut, which certainly looks like what’s happening now. So… Look for further softness and use it as your opportunity to buy at cheaper levels!

This is a NOT a trend reversal people… We’ve seen this various times in the past with the euro. Sooner or later, love is gonna get ya, and then the euro will finally climb over 1.58 to on its way to higher ground… At least that’s the way I see it from my cheap seats!

As I said yesterday, and I’ve been saying since last October… The HUGE capital flows that used to come into the United States are disappearing… And with the current account having problems with financing, the only give is in the dollar.

I’ve heard some economists saying that the Fed is going to step in and not tolerate further weakness in the dollar. Hmmmm…. I wonder where they get this information, don’t you? Since when does the Fed get involved with the currency? That’s the Treasury’s domain. And as long as Treasury Secretary Paulson is beating on China to allow their currency to strengthen versus the dollar, why would he tell the Fed to intervene and support the dollar? Doesn’t make sense to me!

I received some opinions yesterday that differed from mine regarding the Fed bailout of Bear Stearns… And that’s OK! I don’t expect people to agree with everything I say… I am just glad that when they don’t agree, they explain themselves and not get nasty about it.

I still hold onto an email from a guy a couple of years ago (2005) that called me a “know nothing clown” and that I had led him to lose thousands in sterling. I always said that I would ask him when sterling got to 2 and then 2.10 if he still felt the same way… But you know something? My mother taught me not to rub it in someone’s face… And just because they insulted you… You don’t have to stoop to their level. She was right.

OK… Enough of that!

The dollar rally yesterday didn’t interfere with the strength in yen (JPY) and francs (CHF)… Both are HOT, HOT, HOT! OUCH! Better put some Aloe on that burn! However, with the euro sell off overnight, these two were dragged down by the Big Dog. Not much slippage though, and again, it certainly looks like a chance to buy at cheaper levels.

Now, onto the currencies that aren’t performing well versus the dollar… South African rand (ZAR), and Icelandic krona (ISK)… Well… Long time readers know that I’ve always said that I wouldn’t touch rand with “your” ten foot pole… And a lot of people chastised me for saying that, because rand had been able to post some very lofty gains versus the dollar in the past six years… But these are the volatile times with the rand that I have always been leery of… And it’s ugly. In fact, it didn’t just get hit with the ugly stick, it got hit with the whole forest!

Iceland has the same volatility problems as South Africa and now that the carry trade is truly unwinding, these two have warts showing up all over the place. I’m being serious here folks. Iceland has some major problems, one of which is how small the economy is, and how it can be overrun by speculators. But another problem is beginning to show up, and if it continues, it could be really tough times for the krona.

I’m talking about a financial crisis in the banking sector in Iceland… If it gets out of hand… We’re talking whole forest ugly. So… Here’s my thought of the day for you Iceland holders. The next time your CD comes due, get out! And go to something that makes more sense without the warts.

If you want to break your Icelandic CD, you will have to wait until we gather up enough breaks at the same maturity date as yours before the break can be executed… And remember, you lose your accrued interest… And it costs 1.5% in currency conversion costs.

I don’t like having to talk about stuff like that… But it has to be done!

Now… Onto brighter moments in the lives of currencies!

Getting back to Japanese yen… Here’s some proof in the pudding that the yen’s strength is coming from carry trades being unwound. Japan’s Tankan (economic pulse) report showed that sentiment among large manufacturers declined, thus raising expectations that the Bank of Japan (BOJ) will cut rates this year.

At any other time, that news would have “rocked” the foundation of yen… But not now… Not with millions and millions of carry trades being unwound probably as I write!

I keep seeing stories about how investor risk aversion is easing due to the Fed’s bailout of Bear Stearns. Oh, so we’re to believe that it’s OK to get back into the water and take on risk, because the Fed bailed out Bear Stearns? HOGWASH! I say! Anyone that buys into this thought will get their hands trapped in the cookie jar, when it all unravels. But don’t let my opinion get in the way of a “feel good” story.

Another currency that I’ve been warning would get caught up in unwinding carry trades is the New Zealand dollar (NZD)… I received a note from a reader that tells the story of a slowing down of the lumber business in New Zealand. Time to think again about the fact that New Zealand’s current account deficit is over 7% of GDP. Sure the high interest rates have helped the currency to hold the wolves at the door… But I have to wonder for just how long can that go on?

Geez Louise, I’m full of “good news” NOT! This morning, eh? Well… You can’t report stuff on the sunny side of the street every day!

Oh… Another thing denting the euro and Swiss franc this morning was the news that the Union Bank of Switzerland (UBS) reported a first quarter loss of $12.6 billion. UBS has announced that they will be seeking additional capital… That casts an ugly light on European bank finances. The mortgage related write-downs just keep adding up, folks, and now they are infecting European banks. UBS’s loss was larger than expected, and that’s what’s got everyone in a tizzy this morning… I expect this to hurt the euro and franc in the short term… But not drag on, and on, and on.

We’ll see the color of the latest U.S. ISM Index (manufacturing) this morning. I expect to see this come in well below the 50 line in the sand that marks whether we are seeing expansion or contraction in manufacturing. This index first went below 50 three months ago, which is when I said the U.S. had already entered a recession.

The Reserve Bank of Australia (RBA) left rates unchanged last night, which is what I expected they would do. The RBA had lifted rates in each of the past three months, so it was time for them to sit back and see what the landscape looks like. The high interest rates in Australia should be a good foundation and underpin for the Aussie dollar (AUD) going forward.

And finally, in Canada… January’s GDP rose a robust 0.6%, thus erasing, for the most part, the -0.7% drop in GDP that was posted in December. Manufacturing led the way with a very strong showing of 1.7% growth. This report to me, tells us that the Canadian economy was relatively flat for the last few months. That’s much better than the deep six GDP report that printed last month! A flat economy isn’t the thing that a strong currency is made of, but it’s better than a sharp stick in the eye! OUCH! Maybe that was carrying things too far… But it’s a fave saying of the Big Boss, and I thought he would get a kick out of seeing me use it! (OK… I’m not a brown nose, but… Why not try to make the Big Boss smile?)

Currencies today: A$ .91, kiwi .7820, C$ .9725, euro 1.5635, sterling 1.9820, Swiss .9930, ISK 77.75, krone 5.16, SEK 6, forint 165.40, zloty 2.2450, koruna 16.11, yen 100.25, baht 31.45, sing 1.38, HKD 7.79, INR 40.11, China 7.0110, pesos 10.63, BRL 1.7520, dollar index 72.30, Oil $101.04, Silver $16.68, and Gold… $894.35

That’s it for today… I just love those Opening Day festivities at Busch Stadium… The Sea of Red, and all… Gives me chills every year! Today is our Tim Smith’s birthday… He’s an April Fools baby! Tim was the top mortgage producer at EverBank last year, and wanted to broaden his skill set… So, we offered a chance on the currency desk, and he’s taken to it like a duck to water!

The main road to the little river city where I live, was washed out by the recent flooding here… We’ve had so much rain the past few days that it looks like we’ll see more flooding… UGH! Pretty soon the rain and cold weather are going to hurt the farmers attempting to plant their crops. Let’s hope the sun comes out soon! So… Welcome to April, and I hope you have a terrific Tuesday!

Chuck Butler
April 1, 2008

The Daily Reckoning