US Economic Data Sends Mixed Signals

Chuck is headed down to Florida this morning for a couple days of meetings, and as usual, he left me some good stuff for this morning’s Pfennig:

OK… Wednesday, we spent most of the day in rally mode for the currencies. The dollar spent the day in the woodshed, after seeing some weaker economic data in Industrial Production, which fell -0.1%, and Capacity Utilization, which fell -0.2%… No great shakes, but data that wasn’t in line with the recent “strong economic recovery” data we’ve seen lately. Most long-time readers know that I like to see what’s up with Capacity Utilization, because it’s really one of the few “forward looking” pieces of data. Just so you know what I look at… When the US economy was hitting on all 8, in 2007, Capacity Utilization or Cap U, had an index number above 81… In June of 2009, it hit a low of 68.2… It now stands at 76.1, so still a long way from the previous go-go days of the economy, but also a long way from the bottom…and has seen a steady rise since hitting bottom in June of 2009…

If the economy is really going places, we’ll see Cap U continue to rise…

The CABAL (Fed) printed their last meeting minutes yesterday afternoon… The members were more upbeat about the US economy, but still very disappointed with the lack of job growth. The members also expressed their disappointment with the “unevenness of the improvements in labor markets”… Unfortunately, I believe that their disappointment is going to continue, for, a lot of jobs just aren’t going to “come back”… On a brighter note, Home Depot announced that they were going to hire 60,000 “seasonal” workers to fill their busy spring growing season. Yes, they are only “seasonal jobs”, but that’s better than a sharp stick in the eye!

And then there was something that I saw come across the screens, yesterday, from Reuters… It was a message from Israel… ISRAEL FOREIGN MINISTER SAYS TWO IRANIAN WARSHIPS ABOUT TO TRANSIT SUEZ CANAL FOR SYRIA, HINTS AT ISRAELI RESPONSE… Gold went from a negative to a positive for the day, and the Swiss franc (CHF), which until yesterday had seen a softer price, saw a very strong performance… It should be needless to say that the “flight to safety” would be paramount should something become of this… Let’s hope not!

I always appreciate the information Chuck leaves me on his way out the door. And his contribution this morning aligns nicely with what I had prepared last night. On my drive home I listened to a radio announcer talk about Wednesday morning’s economic data. The program pointed out that housing starts rose a strong 14.6% in January after falling just over 5% in the previous month. But offsetting this data was building permits, which were down 10.4%.

The NPR program I was listening to put a positive spin on these numbers, a lot like Ben Bernanke and his compatriots. They all point to a strengthening US economy, which is now predicted to grow 3.4% to 3.9%. But many are starting to worry that this higher growth will lead to higher inflation. Producer Prices rose 3.6% YOY in January, not a major jump, but another indication that consumer prices would probably continue to rise. We will see just how much these producer price rises are filtering through to the consumers today with the release of the CPI data for January.

We will also get the weekly jobless data, which is expected to show another jump in the number of people signing up for unemployment benefits. In spite of all of the positive news regarding the US recovery, unemployment continues to be a major worry. The Fed lowered its unemployment forecast slightly to 8.9% from 9%, but this is still way too high for an economy that is supposed to be recovering.

Worries about STAGFLATION have started to pop back up, and the recent data have certainly increased the risks of this for the US. Prices are definitely on the rise, with commodities leading the way; and unemployment is staying stubbornly high. The Fed could get caught keeping the printing presses on overdrive too long in an effort to stimulate jobs, causing inflation to spiral out of control. I’m not saying this is what will happen, but it certainly looks like it is becoming more and more of a possibility!

Another story I read this morning in The Washington Post pointed to the alarming fact that the interest on the national debt would quadruple in the next decade. This may be alarming to the folks over at The Washington Post, but anyone who has attended one of our presentations is well aware of the problem. We have a PowerPoint slide that I wish I could include in today’s Pfennig, pointing out this growing crisis. Interest on the current debt will easily outstrip spending on Medicare within eight years, and that is the interest on the CURRENT debt. That doesn’t include the additional debt, which the US will undoubtedly have to take on over the coming years.

Not only is our debt going to continue to grow, but interest rates are going to rise. And much of the borrowing the US has done over the past few years has been concentrated in the shorter end of the curve, so we will be refinancing much of this debt over the next five years. With rising inflation, interest rates will likely be rising, which will increase the cost of this interest. Without allowing for any changes to the fixed entitlement programs of Social Security and Medicare, the rising amount of money allocated to interest will choke out all of the other “discretionary” spending. Not a good legacy to leave to our children!

And what happens if foreign investors start to lose confidence in the US, causing interest rates to rise even faster? This would push the US budget deficit even further into the red. The story in The Washington Post ended with a pretty scary comparison of the US to European nations such as Greece or Portugal, which have similar debt as a percentage of GDP. The only problem is that the US does not have the ECB or IMF to turn to. We are going to have to figure our own way out of this mess, and the first step is to try and reduce government spending!

OK, enough of the scary stuff on the problems here in the US, it can put me in a negative mood and I want to try and stay positive. The best performing currencies in the overnight markets were the Swiss Franc, Canadian dollar (CAD), and South African rand (ZAR). The Swiss benefited from the rising tensions in the middle east. The story regarding Iranian warships in the Suez canal caused a flight to safety which benefited the Swiss which is still seen as a “safe haven.” The tensions also caused gold to turn around and move positive overnight, helping the South African rand, which has been in a downward trend since the beginning of the year. Gold is getting help from two different sources; both inflation concerns and worries about the civil unrest in the Middle East have combined to give the precious metals another boost.

The Canadian dollar moved higher mainly due to the positive economic data here in the US. The loonie has stalled a bit lately, trading in a fairly tight range since the beginning of the year. But a stronger US economy along with increases in commodity prices could force the Canadian dollar higher. But I still worry that the Canadians don’t really want their currency appreciating too far past parity with the US dollar, so we could see them trying to keep a lid on any major moves higher. The positive US data was also beneficial to our neighbors to the south. The Mexican peso (MXN) started 2011 with a strong move higher, but has stalled out lately. The positive housing starts here in the US gave the peso a bit of a push up, and it will also benefit from rising oil prices.

As Chuck pointed out yesterday, Moody’s warned that Australia’s top four banks could face a downgrade to their credit ratings. But the markets shook off the warnings as the Australian dollar (AUD) held firm above parity with the US dollar. I read two different stories this morning concerning Moody’s warning, and both thought that Moody’s was, as usual, late to the game. A Bloomberg article quoted a bond trader from Royal Bank of Scotland as saying “Fixed income investors are well aware of the issues that prompted Moody’s move, so I don’t think the debt market will respond much.” This is one of my pet peeves with the ratings agencies. They are constantly stating the obvious, and rushing in to adjust ratings after the markets have already made their adjustments. They typically “pile on” after the fact, and push the markets to over correct one way or the other. So it was nice to see the currency and debt markets blow off these belated warnings.

To recap: The data released yesterday in the US gave mixed signals, with housing up but inflation also rising. Obama’s budget points out the rising costs of our borrowings. The Swiss francs were the best performer overnight, benefiting from “safe haven” flows. The South African rand moved higher with gold, and the markets shrugged off Moody’s warnings about Australian banks.

Chris Gaffney
for The Daily Reckoning