Waiting for the Fed

Good day. It is great to be back at work; with two young kids, I need a rest after my week of vacation! The currency markets will likely take a break today, as they wait for the FOMC rate decision, which will be released tomorrow.

Friday saw a durable goods number that surprised the market on the upside, coming in double the expectations at +2.6%. Compare this to last month’s revised number of -8.9%.  This number rallied the dollar at first, but then we got the new-home sales data, which led to a dollar sell off. Chuck left me this on Friday’s rollercoaster trading:

“Durable goods orders rebounded by 2.6% in February, after January’s 8.9% plunge. The details of the report were weaker. When you take out transportation, orders fell 1.3% compared to estimates for a 1.1% gain. Orders for non-defense capital goods excluding aircraft, which correlate well with machinery and equipment investment, fell 2.3%, which falls right in line with my view that corporate/business spending will come to a snails pace as we head to the second half of this year.

“New home sales…talk about an offset to the existing home sales data! What? Is everyone buying nothing but old homes now? With the median price of existing homes falling, I can see that! As Bill Bonner says, ‘The McMansions’ could be too steep in price now. I wonder what this housing sector will bring us next?”
In addition to the FOMC rate decision, Tuesday will also bring us the consumer confidence numbers. On Thursday, we get the fourth quarter GDP, which is expected to be slightly higher than the third quarter figures. We’ll also see personal consumption and the weekly employment figures. Friday will end the week with the release of personal income and spending data, University of Michigan confidence, and the Chicago purchasing number. 

Today, the focus will continue to be on the FOMC meeting. While a 0.25% rate hike is “in the bag,” the markets will be looking to see what new Fed Chairman Ben Bernanke has to say regarding future interest rate moves. An end to increases by the FOMC would stop a widening of the rate premium over both Europe and Japan, which helped push the dollar 10 percent higher versus these currencies, last year. As Chuck pointed out above, the cooling housing market will definitely make it more difficult for the Fed to continue to raise rates. Without this interest rate differential to fall back on, the currency markets will refocus on underlying fundamentals, which are negative for the U.S. dollar.

The Japanese yen will likely advance this week on speculation that China will take additional steps toward allowing the renminbi to strengthen against the dollar amid pressure from politicians in the United States and Europe who say the government has kept the currency weak to bolster exports. A report by Morgan Stanley’s head of currency strategy, Stephen Jen, agrees with this assessment. Jen writes, “The yen and yuan are mispriced and should appreciate against the dollar. If they appreciate, the other Asian central banks will be more likely to allow their currencies to move higher.”

As we have been saying over the last few years, China is the key to rallying all of the Asian currencies. A stronger renminbi will make Japanese and other Asian country’s exports more competitive with Chinese goods. We expect the Chinese will let the renminbi break the eight “handle” very soon. 

The Australian dollar finally leveled off Friday, after a bad week. Last week’s 2.6% sell off to an 18-month low was too rapid, given the fact that the Aussie will likely maintain its interest rate advantage over the U.S. dollar. I think we will likely see the Aussie strengthen this week on speculation the FOMC will signal that it’s close to ending their interest-rate hikes. Australia’s key interest rate is the highest of any country with a top credit rating, which cause the currency to bounce back from last weeks disappointing showing.

As Chuck pointed out last week, the Australian dollar has, unfortunately, been tarred with the same brush as the New Zealand dollar. The kiwi plunged to a 22-month low last week, as a government report showed its economy shrank last quarter. The kiwi is also being sold off as a result of the unwinding of carry trades. But, the kiwi isn’t alone in this sell off; all the emerging markets have been getting hit. Again, Chuck has been talking about this, at length, and left me the following for this morning’s Pfennig:

“Besides the mess in the emerging markets and the unwinding of the carry trades. Now, Mexico has to deal with lower interest rates. I want everyone to recall that I’ve repeatedly said that once Mexico lost its “risk premium” that it paid in high interest rates, the currency would get hurt. Mexico’s central bank cut rates today (Friday) to an 18-month low. The risk premium is going away, and so is the strong performance of the peso.”

Finally, gold continues its move up as investors buy bullion for protection against a falling dollar. Our new Metals Select accounts are an excellent way of taking advantage of this appreciation. Precious metals are a separate asset class and should be held in addition to currencies. Gold and silver are both an excellent inflation hedge and should be owned by most investors. Call the desk at 800-926-4922 to find out how easy it is to own metals through EverBank’s new Metals Select program.

Now on to the big finish:

Currencies today: A$ .7071, kiwi .6087, C$ .8534, euro 1.2029, sterling 1.7471, Swiss .7646, ISK 72.30, rand 6.2515, krone 6.6237, forint 219.64, zloty 3.247, koruna 23.84, yen 118.54, baht 38.93, sing 1.6184, China 8.02, pesos 10.89, dollar index 89.94, silver $10.90, and gold $563.79

That’s it for today. Sorry it is a little short this morning. It takes some time to get back into the groove of the currency markets. We don’t have any data today, so look for pretty flat markets waiting for the FOMC decision. I hope everyone has a great start to the week.

Chris Gaffney
March 27, 2006

The Daily Reckoning