Trade Gap Widens But Does Anyone Care?

Good day… It’s Friday!! We have had a busy week here on the desk, as investors have been moving more funds into the currencies and taking advantage of their last opportunity to purchase our Japanese REIT MarketSafe CD. Currencies have had their best week in a year versus the U.S. dollar, with several hitting record highs.

Reports released yesterday showed the trade deficit increased to $60 billion in May. As we expected, exports increased to record levels but were offset by a jump in oil prices. Most news stories brushed aside the increase in the trade gap and focused on the increase in exports. Chuck pointed this out in an email to me last night:

“So… Here we are. The pundits like to make a big deal out of what they call a ‘narrowing’ of the trade deficit whenever it drops a billion or two. But where are they when the trade deficit gains a billion or two back? Nowhere to be found! So, let me fill you in with the details… The U.S. trade deficit widened to $60 billion in May from $58.7 billion in April…

“You know what’s really strange about the widening is that exports were up 2.9% in May, and 11% on a year-on-year basis. So… The weaker dollar is helping exports just as we always said it would. Unfortunately, U.S. consumers can’t seem to put the Visa card away. I just cringe when I think of these things, because one day they will have to pay the piper.

“Now, just to the north of us in Canada we have a different story going on. Canada’s merchandise trade surplus came in stronger than expected, holding steady at April’s upwardly revised $5.9 billion. How nice it is to know that you don’t have a deficit dragging down your economy. And speaking of Canada’s economy…

“The latest minutes from the Bank of Canada’s monetary policy committee tells us that The Bank of Canada acknowledges that with their economy operating further above its potential, additional rate increases may be required. You bet they will be required!

“Recall two years ago when I wrote about my trip to Vancouver and the local newspapers were writing about how the Canadian economy was ‘juiced’? That was a reference to the economy being fueled by coal, oil, and natural gas. Well… Guess what’s hot to trot again? You’ve got it! And it all plays into what we’ve been telling people for months now… The Energy sector is hot! Which is why we created our World Energy CD. If you haven’t looked into it, or missed class those days we tried to pound it into everyone’s heads… Check out our website or call the trading desk at 1-800-926-4922!”

Chuck is obviously pumped up (pun intended) about our WorldEnergy CD! The price of crude oil has climbed 20% this year and investors in our WorldEnergy Index CD have been able to take advantage of this move.

Today we will get reports detailing advance retail sales in the United States, along with U. of Michigan Confidence and business inventories. The retail sales numbers will be the most watched of these numbers and is expected to be slightly lower in June. A drop in demand for automobiles and home supplies will be the reason for the drop in the numbers. So the meltdown of the housing industry continues to reach out into other parts of our economy. I have got to believe we will see the housing slowdown as the reason for all kinds of negative reports on our economy. Get used to it, as we have just started to see some of the impact this mortgage mess will have on our economy.

Chuck agrees, and pointed out in an email to me yesterday that the “carry trade” could be another victim of our mortgage meltdown:

“Since the subprime mess has resurfaced with the markets, obviously never leaving our stream of thoughts though, there could be a change in the weather for the carry trades. The subprime problems have brought risk back into the equation. And if this brings about a change in the non-risk aversion, which I believe it will… Watch Out!

“A return to risk aversion would mean an unwinding of carry trades…and a boost for the Swiss franc (CHF) and Japanese yen (JPY).

“The other thing that I’ve seen over and over again the past few days is the strong stance of ECB President Trichet… Yesterday, he was quoted saying a couple of things:




“All this tells me that the euro (EUR) is not going to stop at 1.40, as I previously called. With this type of support, and the weakness in the dollar from the subprime/mortgage meltdown, the euro could very easily move as high as 1.45! WOW!”

I told you Chuck was feeling better and pretty much wrote the entire Pfennig for me this morning. I told him to keep it coming, I know we all like to hear his thoughts and views on the markets.

Chuck isn’t alone in his opinions on the euro. The chief technical analyst in Toronto at RBC Capital Markets, George Davis, said the euro is “poised to test $1.3855”. According to Davis, this level represents the upper boundary of the euro’s ascending channel, connecting the highs of June 5, 2006, December 4, and April 27. A break of the upper boundary would suggest faster gains. “With our target of $1.36 hit two weeks ago, we are establishing $1.39 as our new target based on our bullish stance,” Davis said. As readers know, we aren’t “chart guys” here at EverBank. But when the technical analysts agree with our fundamental analysis of the European economy, it means the euro is due for a nice steady climb versus the dollar.

South Africa’s rand (ZAR) rose against the dollar, heading for its third week of gains, as expectations of higher interest rates helped move the currency higher. A report yesterday showed quicker than expected manufacturing growth and added to speculation that the Reserve Bank will raise borrowing costs further. Manufacturing growth accelerated to 4.5% in May from the month before, the fastest pace since May 2004.

And finally, the Chinese renminbi (CNY) will close out this week with its biggest weekly gain since the end of its dollar link in 2005. Record trade surpluses drove foreign exchange reserves to an all time high, boosting excess cash in the financial system and making it more difficult for the government to cool economic growth. So the Chinese government is being forced, not by U.S. congressman, but by the markets, to let the renminbi’s value rise. We have talked at length about how the Chinese government will move at its own pace on the valuation of their currency, and now it looks like they have decided to step on the gas. A combination of higher interest rates and higher currency levels is just what is needed. I would look for more of the same out of China in the coming months.

Currencies today: A$ .8678, kiwi .7862, C$ .9551, euro 1.3778, sterling 2.0323, Swiss .8310, ISK 60.09, rand 6.9550, krone 5.7428, SEK 6.6434, forint 178.21, zloty 2.7183, koruna 20.5485, yen 122.39, sing 1.5148, HKD 7.8181, INR 40.4050, China 7.5725, pesos 10.7557, dollar index 80.673, Silver $13.15, and Gold… $668.00

That’s it for today… I will close today’s Pfennig with a Happy Birthday wish for my mother. She was a great mom, but watching her with my kids has made me even more aware of just how wonderful she is. My kids always look forward to going over to her house where they are spoiled to death! It is supposed to be an absolute gorgeous weekend here in St. Louis, so we have made plans to take her to the boathouse down in Forest Park, which was built for the 1904 world’s fair. Hope everyone has a good Friday the 13th!!

Chuck Butler — July 13, 2007

The Daily Reckoning