U.S. Economy Slowing

Good day… The dollar was down slightly throughout the day yesterday after the data showed that the U.S. economy is slowing. The big release yesterday was the final estimate of third quarter GDP, which was expected to remain at 2.2% but instead contracted to 2.0%. Personal consumption, Core PCE, leading indicators, and the weekly jobs data came in right where they were expected. Ending the data for the day, the Philadelphia Fed index showed a sharp reversal, coming in at negative 4.3 after posting a positive 5.1 in December.

This is why Chuck hates these regional manufacturing indexes; they can be extremely volatile! But the overall feel of the U.S. data yesterday was just what we have been expecting. The U.S. economy is slowing with only the resilient U.S. consumer spending keeping us afloat. The rate increases over the past few years are finally having their desired affect, now we have to wait and see if they went too far. The economy has moderated, but can we keep it at these ‘slow growth/no inflation’ levels or will we slip into the more dangerous ‘no growth/rising inflation’?

We will end the week today with personal income and spending, PCE deflator and core, durable goods orders, and the U of Mich. Confidence numbers. As I touched on above, it’s likely consumer spending rose in November at the fastest pace in four months, propelled by retailer discounts. I think everyone knows my opinion of our buy now and pay later economy. Higher spending is the one factor keeping the U.S. economy going, and will be a major factor in determining the timing of the FOMC’s decision to cut rates. If this month’s report shows consumers continuing to spend, which I think is likely, the fed will not see a need to cut rates in early 2007.

The pound sterling got a lift overnight after a report showed that U.K. service industries grew for a third month in October, supporting the fastest annual pace of expansion in two years. GDP rose 2.9% from the previous year, more than the 2.7% official estimate. This robust growth (for the United Kingdom) will likely cause the Bank of England to raise interest rates in 2007. Any increase by the BOE will likely cause the pound sterling to push back up toward the $2.00 mark.

As I reported yesterday, Iceland raised rates in a surprise move to try and cool their economy. While you would expect this increase to help the krona, many feel the high rates will force the Icelandic economy into a recession. Icelandic central bank governor Fridriksson said this concern is ‘overdone’ and the possibility remains that the bank will raise interest rates further. “We haven’t closed any doors and we don’t rule anything out,” Fridriksson said yesterday. “The economy certainly needs to cool down, to take a breather. I wouldn’t say we’re heading toward recession. Talk of a recession is overdone.” Inflation has slowed to 7% this month, but the senior director of Fitch Ratings continues to warn of potential problems.

Asian currencies held steady again with the Thai baht actually moving up a bit versus the U.S. dollar. Thankfully, the ill-timed move by the Thai central bank has not caused a currency crisis. In fact, with their U-turn for investments in the Thai stock market, the biggest impact has been on the credibility of the new Thai government. The yen should get some support today after the release of the minutes of last month’s BOJ board meeting showed some members favor accelerated rate increases. These hawkish comments show the BOJ is leaning toward raising rates in early 2007.

Currencies today: A$ .7859, kiwi .6994, C$ .8654, euro 1.3193, sterling 1.9649, Swiss .8233, ISK 69.63, rand 6.98, krone 6.2077, SEK 6.8116, forint 191.35, zloty 2.8971, koruna 20.88, yen 118.43, baht 36.40, sing 1.5398, HKD 7.7767, INR 44.56, China 7.8163, pesos 10.8493, dollar index 83.46, Silver $12.46, and Gold… $619.10

That’s it for today… It smells great in here this morning, as everyone in bringing in food to celebrate Christmas. The currency markets will be very light this morning, as most traders have already left for the holidays. Happy Holidays to everyone!!!!

Chris Gaffney
December 22, 2006

The Daily Reckoning