U.S. Consumers Running Scared

Good day… As expected, consumer confidence in the United States fell in March, which kept the dollar moving down versus most of the currencies. The drop in confidences was widely expected, so the currency markets didn’t move as violently as they did on Monday.

Today we will get the durable goods numbers, which are expected to show a substantial turn around from last month’s numbers. The January reading of durable goods orders showed a dramatic drop of 8.7% with the ex-transportation number still showing a drop of 4%. February’s numbers are expected to show an increase of 3.5% for the total and 1.8% for the core number. If these numbers come in as expected, you could see a good buying opportunity for the currencies, as the dollar will likely move up after the past few days of losses.

As in the past, much of the drop in confidence was linked to a run-up in gasoline prices, which seemed to be the main determinate of consumer optimism. When prices at the pump go up, consumers immediately feel the pinch and start to worry.

But I don’t necessarily think this is a bad thing. We have been trying to get the U.S. consumer to wake up and smell the coffee for a while now. Yes, the pull back in consumer spending would be a short term negative for the U.S. economy, but the borrow and spend tradition of our consumers has landed us into the predicament that we now face: An economy with way too much debt (both public and private) and not enough savings. A little wallet tightening is a good thing for our economy in the long run.

If this drop in confidence continues, it will definitely carry ramifications for the Federal Reserve and interest rates. The U.S. consumer has helped bail out the Fed over the past few years when they were forced to increase interest rates to combat rising inflation. Without the U.S. consumer there to bail them out, the FOMC may not be as quick to raise rates in order to combat inflation. It seems we are moving closer to that ‘perfect storm’ Chuck has referred to in past Pfennigs: Higher inflation (mainly due to oil), slower growth, falling home prices, and an overburdened U.S. consumer. I sure wouldn’t want to have to try and steer the U.S. economy out of this one!!

Another piece of data released yesterday didn’t get much airtime on the national news, but it is another indication of the direction I believe the U.S. economy is heading. The S&P/Case Shiller index showed that home prices dropped in January for the first time in at least six years. As you all know from my diatribe yesterday, I believe this is just the beginning of a long slow spiral down for the housing industry!

I better move away from the United States before I get back up on my soapbox! European money supply growth unexpectedly accelerated to the fastest pace in 17 years in February, strengthening the case for the ECB to keep raising interest rates. M3 money supply (which the ECB uses as its main gauge of future inflation but which the U.S. Fed decided to stop publishing) rose 10% from a year earlier after rising 9.9% in January.

Also giving the euro some reason to rally was a report from Germany that showed consumer confidence rose for the first time in five months. Still another report released this morning showed Ireland’s economy grew 5% in the fourth quarter, as hiring boosted consumer spending, lifting full-year growth to 6%, the fastest in four years. Ireland’s economy has more than doubled in size in the last decade and continues to be one of the stars of Europe.

The combination of data released today all but assures the ECB will need to continue raising interest rates in the near future, which will increase the interest rate differential to the United States and continue to move the euro toward 1.40. As I suggested in the opening paragraph, if the GDP numbers released this morning move the dollar up, use the opportunity to add to your positions in the currencies, especially if the euro slips below 1.32 (which I don’t expect, but could be possible).

In other news out of Europe, Swiss leading indicators rose for a second month in March. As we reported in this month’s Review and Focus, the Swiss franc has been under a lot of selling pressure lately due to the ‘carry trade’. Fundamentals of the Swiss economy show that the franc is currently undervalued, and could rise dramatically if we start to see the carry trade reversed. Recent interest rate increases in Switzerland now mean you can actually earn a little interest while holding the currency (the three month APY is currently 1.12%). The Swiss franc is also part of our Euro Trax Index CD, which has recently been one of our most popular investments for diversification in the European region.

The other two currencies involved in the EuroTrax index were also in the news this morning as the Norwegian krone and Swedish krona rallied on good economic reports. Swedish retail sales rebounded in February after posting the biggest drop in almost two years the previous month. Retail sales had been weak in the beginning of the year, so the move up was a relief. Strong confidence among both households and companies in the retail sector should keep the Swedish economy moving in the right direction.

In Norway, the unemployment rate hit a 20-year low causing the governor of the Norges Bank (Norway’s central bank) to warn that interest rates will have to rise to combat wage-driven inflation. The Norwegian krone has been one of the best European currencies versus the U.S. dollar in 2007, and should continue to benefit from booming economic fundamentals in the coming months. The tick up in the price of oil will also help this currency.

The yen moved up nicely last night, dropping back below the 117 figure. Bank of Japan governor Fukui said he’s monitoring land prices after a report that showed gains of as much as 46% in parts of Tokyo last year. “We aren’t yet in a situation in which land price gains warrant concern of excessiveness, but we’d like to keep a close watch on them,” Fukui said in parliament today. Rising real estate prices will likely continue to pressure the BOJ to raise rates in order to avoid a repeat of the asset-price bubble that led to more than a decade of economic stagnation. Any move up in interest rates will help to move the yen back up in value.

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Currencies today: A$.8068, kiwi .7137, C$ .8623, euro 1.3343, sterling 1.9649, Swiss .8254, ISK 66.16, rand 7.284, krone 6.0948, SEK 6.9881, forint 186.65, zloty 2.9075, koruna 21.007, yen 117.22, baht 31.77, sing 1.5184, HKD 7.8136, INR 43.0675, China 7.7295, pesos 11.0743, Silver $13.375, and Gold $666.45

That’s it for today…A little shorter than yesterday as I am running late this morning. Took my 8-year-old daughter to the Blues game last night, we saw a losing effort, but still had a good time (she goes to the games for the Dippin’ Dots!) Rainy day here in St. Louis, hope the weather is better for Chuck down at spring training!! Have a great hump-day!!

Chuck Butler — March 28, 2007

The Daily Reckoning