U.S. Data Continues to Disappoint

Good day…More disappointing data in the United States kept the dollar down Wednesday, and the data due out today looks like it will be more of the same. The U.S. economic slowdown that we have been warning about is finally starting to show up in the data. Like I said yesterday, I sure wouldn’t want to be in Bernanke’s shoes right now. The FOMC is going to have a very difficult choice in the coming meeting, since growth in the U.S. economy is slowing to a point that may need lower rates, but inflation is still their main concern.

Durable goods orders, as reported yesterday morning, increased from last month’s abysmal showing, but were still below expectations. The overall number increased 2.5% compared to last month’s revised drop of 9.3%. The core number (ex transportation) was down 0.1% after last months drop of 4%. Usually after every day of data you will get at least someone who creates a positive spin on the numbers, but these numbers were so bad there was no way to spin them. Instead, the news media just kind of ignored them and moved on to today’s GDP numbers.

I don’t think we will see many positives in today’s release of fourth quarter GDP either. Expectations are for the GDP figures to match the Commerce Department’s preliminary report last month of a 2.2% growth. There is a danger the number could come in slightly lower, as the economy has been hobbled by slumps in home construction and business spending which show no signs of recovery.

The U.S. economy grew at a 2% rate in the third quarter, so some may trumpet a 2.2% growth figure as ‘improving’, but we all know our economy is not heading up; it is, in fact, slipping further down the slippery slope toward recession. We will also see the weekly employment figures released, which will likely show an increase in jobless claims. Not good news for the United States.

Foreign investors are finally starting to pull back from buying our Treasuries as a government sale of securities yesterday drew fewer bids from foreign investors than last month. Today we will get an auction of five-year debt so we will have to see if the foreigners stay away.

The lack of foreign interest pushed yields to near the highest in more than a month but the spread of U.S. treasuries over German or Japanese bonds continues to shrink. Five-year U.S. notes currently yield just 50 basis points over similar maturity German bunds, the least since 2004.

Recent data out of Europe shows that this interest rate gap will probably tighten even more as all signs point toward more aggressive interest rate increases by the ECB. Retail sales in Europe rose for the first time in three months in March as German consumer spending recovered from a tax increase at the beginning of the year.

Faster economic growth has spurred hiring and spending as German unemployment dropped to a six-year low according to a report released this morning. The European Commission said the faster hiring in the euro area my boost wage demands by workers and push up inflation, echoing central bankers who have indicated they see a need to increase interest rates further.

So the euro region and United States are heading in two different directions, which will definitely be reflected in their currencies. Buy euros and sell dollars.

Rates also will be going up in the United Kingdom according to a report released today by JPMorgan Chase & Co. Malcom Barr, Chief economist at the bank, who wrote, “We are pulling the rate hike we had forecast for August forward to May”. It is always nice to see economists at the “big banks” agreeing with what we have been saying. The pound sterling should continue to appreciate versus the U.S. dollar on the future interest rate increase.

As I reported yesterday, the Swiss franc should also benefit from increasing rates. The Swiss National Bank said that it will probably raise interest rates further to counter inflation. The SNB “will probably have to continue its policy” of a gradual rate normalization, the Zurich-based bank said in its quarterly report today. “From mid-2007, inflation will rise to a bigger extent,” than previously expected, it said.

The Swiss franc has been held down due to the carry trade, as their low interest rates and excellent banking system has made it on of the preferred funding currencies for this carry trade. As in Japan, an increase in Swiss interest rates will make the carry part of the equation more expensive. As investors reverse the carry trade, they will be purchasing Swiss francs, which will push the value of the franc up.

The other funding currency for the ‘carry trade’ is the Japanese Yen, which also got some good news yesterday. Sales at Japan’s biggest retailers rose for the first time in five months, signaling that the country’s economic expansion may be spreading to consumers. Consumer spending accounts for more than half of Japan’s economy and a rebound will help sustain growth. Reports tomorrow are expected to show that unemployment matched an eight-year low and that household spending rose for a second month, following more than a year of declines.

Finally, did you see where Senators Schumer and Graham are back at it again? Yes, they are now drafting a new, scaled back measure aimed at getting China to raise the value of its currency. As you will recall, the esteemed Senators withdrew legislation that would have imposed a 27.5% tariff on Chinese imports unless the Renminbi was allowed to strengthen faster. Have the Senators not learned anything from their last attempt? I agree that China needs to let their currency increase, but they are going to do it on their own timetable and not because a couple of Senators are threatening them.

China has begun to increase interest rates to slow down their economy, and a faster appreciation of the renminbi will also help to slow it down. Again, I think a further increase in the renminbi is inevitable and will be a positive for all of the world’s economies, but a trade war is not the way to make that happen.

Currencies today: A$.8095, kiwi .7138, C$ .8626, euro 1.3344, sterling 1.9644, Swiss .8235, ISK 66.06, rand 7.3177, krone 6.0751, SEK 6.9978, forint 186.43, zloty 2.9085, koruna 21.03, yen 117.44, baht 31.33, sing 1.5180, HKD 7.8128, INR 43.71, China 7.7280, pesos 11.0593, Silver $13.335, and Gold $665.15

That’s it for today… Today is the day we will get our little Christine back from maternity leave. Linda has done a terrific job filling in for her, but it will be great seeing Christine’s smiling face back on the trade desk. In celebration of Christine’s return, Sue has agreed to get us Chinese (it is a long drive back to our original office location where the best Chinese food in St. Louis is found). Yahoo!!! It’s going to be a GREAT DAY at EverBank!! Hope you have a great day too!

Chuck Butler — March 29, 2007

The Daily Reckoning