Vacation Week

Good day… And welcome to July! I am writing this morning from the beautiful city of Boston. From the full hotels and restaurants, I can tell you first hand that we are in the prime summer vacation week. With many hedge fund managers and currency traders off the trading desks, the markets will be thin during this holiday-shortened week. But a few key snapshots of the U.S. economy along with rate announcements by the Bank of England and the European Central Bank should give the markets some direction.

Today the ISM’s June manufacturing index is expected to come in at 55.5, indicating a slightly stronger expansion than May’s reading of 55. The Commerce Department’s report on May factory orders which is expected to show a 0.3% drop, is due out tomorrow along with a report of auto sales for the month of June. The ISM’s index of the service sector in June will come out Thursday, and is expected to slip to 58 from 59.7 in May. We will also get the weekly jobs data, which will largely be overshadowed by the Labor Department’s June employment report due out Friday. Unemployment is expected to have held steady at 4.5% in June, and non-farm payrolls probably rose by 130,000, a smaller rise than May’s. With the recent negative data regarding the housing market, June’s employment figures could miss forecasts.

As I indicated earlier, the markets will be thin this week, so any surprises in this data could dramatically affect the markets. I think the risks are that the U.S. data disappoints, and the dollar continues to get sold.

The euro (EUR) and pound sterling (GBP) both held onto their recent gains over the weekend and look set to appreciate further as we await Thursday’s rate announcements. The euro is clearly on track to move back above 1.36 as interest rate differentials with the United States continue to tighten. The European economy continues to expand, helping to bring down unemployment and pressuring the ECB to continue to raise rates. Manufacturing growth in the euro region, as reported this morning, accelerated more than initially estimated in June. Royal Bank of Scotland Group PLC said its index of manufacturing in the 13 euro nations rose to 55.6 from 55 in May. Any reading above 50 indicates growth.

On Friday it was announced that the unemployment rate in France reached a 25-year low. This improvement will give new President Nicolas Sarkozy a welcome boost as he prepares to unveil laws at relaxing the labor market. Sarkozy’s pledges of economic reform have already lifted consumer morale according to the most popular gauge of current consumer sentiment, which climbed in June. So now France is set to join Germany on a positive growth track, and the economic engine of the Eurozone looks like it is going to running on all cylinders. The ECB will undoubtedly announce another rate increase on Thursday, and with the thin markets, we could see the euro move over 1.37 by weekend.

The pound sterling gained for a fifth day, holding above $2.0 despite the increased terror threat level. I was glad to see investors kept their heads after the discovery of the two car bombs in London and the suicide explosion in Scotland. Prime Minister Gordon Brown’s new government seemed to handle the threat convincingly and most traders carried on as usual. Sterling traded above $2.01 after the U.K. purchasing managers survey suggested the manufacturing sector is continuing to expand at a robust pace as firms continue to raise employment and prices.

It’s all but guaranteed that we will see a 25 basis point increase by the BOE on Thursday, and there is an outside chance we will see them raise by 50 bps. As I reported over the past few weeks, BOE’s leader Mervyn King has been in favor of more aggressive moves by the policy makers. Thursday’s rate announcement would be a perfect opportunity for them to show the markets they are serious about reigning in inflation. With rates moving up, the pound sterling looks like it is now firmly entrenched above $2.00.

The yen (JPY) moved up after the Tankan, Japan’s most closely watched business survey, showed sentiment held close to a two-year high. Confidence among Japan’s largest manufacturers was up, and companies said they’re increasing spending, supporting the central bank’s argument for raising interest rates. This survey confirms the healthy sentiment of large companies, and supports expectations that the BOJ will raise its key overnight rate in August. Japan’s jobless rate held at 3.8% in May, a nine-year low, helping spending by households climb for a fifth month. Consumer spending and exports drove the economy’s 3.3% annualized first quarter growth. While a rate increase is expected in August, the carry trade will keep selling pressure on the yen in spite of all of the positive economic news. A global move away from risk, or extended rate increases by the BOJ are needed to reverse the carry trade and its massive short positions on the yen.

While the carry trade continues to hold down the Japanese yen, the Swiss franc (CHF) seems to be breaking free and continues to move up versus the dollar and euro. The Swiss franc posted its biggest advance in more than a week on speculation that faster manufacturing growth will prompt the central bank to raise lending rates, reducing the appeal of so-called carry trades. The currency rose for a second day after Credit Suisse Group said its June manufacturing index rose to 62.8 from 58.9 in May. The Swiss franc should continue to be undervalued, and should make up lost ground on the euro as the Swiss National Bank gets aggressive on their rate increases.

The commodity currencies of Australia, New Zealand, and South Africa have all had very nice gains lately as a combination of higher interest rates and strong commodity markets have given them support. The Australian (AUD) and New Zealand dollars (NZD) rose to the highest levels in about two decades versus the U.S. dollar as yield premiums widened. Yield premiums also helped the South African rand (ZAR), which reached a six-week high. Statistics released in South Africa last week showed that inflation exceeded the bank’s target range for a second month in May. Central bank Governor Tito Mboweni said last week that interest rates were “too low”. The South African Reserve Bank raised the benchmark lending rate by 50 basis points on June seventh and next decide on rates on August 16.

Gold and silver rose in London on speculation higher raw material costs and a weaker dollar may revive demand for precious metals as a hedge against inflation. The metals also gained after investors bought it as a safe haven following the attempted car bombings in London.

Currencies today: A$ .8566, kiwi .7794, C$ .9444, euro 1.3586, sterling 2.0108, Swiss .8239, ISK 61.89, rand 7.014, krone 5.866, SEK 6.8169, forint 180.71, zloty 2.7646, koruna 21.48, yen 122.68, sing 1.5250, HKD 7.8161, INR 40.63, China 7.6050, pesos 10.774, (no dollar index quote),Silver $12.54, and Gold… $653.10

That’s it for today… Boston is great! We spent a beautiful day at Fenway yesterday and had some great seats to watch my son’s favorite team get beat by the Texas Rangers. Today is the day our Jennifer is scheduled to go in to the hospital to have her baby, so I will have some big news tomorrow on the new arrival. Hope everyone has a great start to their week!

Chuck Butler — July 02, 2007