Waiting for the FOMC

Good day. The dollar continued to trade in a tight range yesterday as the markets await the FOMC rate hike and accompanying statement due out tomorrow. While a 25-bps hike is already “baked in the cake,” there have been recent calls for a 50-bps surprise to “shock” the markets into believing the new Fed Chief is serious about keeping inflation down. I still think a 25-bps raise will be what we get, but the accompanying statement will show a continued tightening bias, which will continue to keep the dollar bulls happy.  With no real data due to be released this morning, look for any activity in the markets to be generated by continued speculation on the FOMC’s actions. It should make for another boring day in the markets.

I spoke to a few different investors yesterday who were trying to trade on the upcoming release by the FOMC and wanted my opinion on what would happen to the currency markets. I freely offered my opinion, just as I have in the first paragraph. But then, I went on to remind them that our attitudes toward the investments we offer are slightly different than what these “traders’ were trying to do. At EverBank, we continue to believe that currency and metals investing is something you do for diversification, not just for daily profits.

For individual investors, trying to time the markets and trade off of FOMC interest rate actions is usually a losing proposition. There are just too many possibilities to try and predict. And even if you get the interest rate call correct and predict what the accompanying statement will say, the markets don’t ever seem to react as you would have thought they would. For example, last Thursday leading indicators came in below expectations, and on Friday the durable goods orders also came in well below expectations. You would expect both of these items to cause a sell off in the U.S. dollar since they reflect the poor fundamentals of the U.S. economy and would also predict a pause by the FOMC. But as Chuck reported, the dollar rallied on both pieces of data.

Don’t get me wrong, I think that it is important to try and get a general feel for where the markets will go given certain circumstances. But it is more important to look at the overall asset allocations in a portfolio and make sure you are well balanced and diversified. The investments we offer don’t use leverage, so the average investor will not be able to use them to profit off of short-term swings in the markets. You should use our products as a way to hedge your portfolio against the risks of a falling dollar and of higher inflation (both risks that are very much on the horizon). So, no matter what the FOMC does or announces tomorrow, currency and metals should be in everyone’s portfolios. Even if the Fed increases by 50 basis points, the fundamentals of the U.S. economy have all but guaranteed the U.S. dollar will continue to weaken over the next few years. Sorry about my getting off track a little bit there, but I wanted to try and explain where we are coming from. Now, back to the currency markets!

The Euro saw more good news as consumer confidence in Germany rose to the highest in almost five years as households showed a greater willingness to spend. This follows the unexpected jump in business confidence yesterday and unemployment in May, which posted the biggest drop this year. If it weren’t for the FOMC meeting tomorrow, this data would have undoubtedly caused the Euro to jump more than it has. And soccer’s World Cup currently being held in Germany, while not big news here in the United States, is the largest sporting event in the world. It will undoubtedly help boost the German economy for the month of June. So, look for the good numbers to continue out of Europe, giving continued strength to the Euro.

As Chuck mentioned earlier this week, six ECB council members in the past week have suggested the bank may be more aggressive in increasing interest rates as inflation risks rise. Even ECB President Trichet got involved yesterday as he said that they will remain “permanently alert” on inflation concerns; a rather hawkish sounding tone.

The yen continues to come under selling pressure on concern Bank of Japan Governor Toshihiko Fukui may resign, clouding the outlook for the central bank’s first rate increase in almost six years. A recent poll showed 67% of Japanese surveyed said Fukui should resign over his investment in a fund founded by Yoshiaki Murakami, who has been indicted for insider trading. While the Prime Minister Koizumi reiterated he wants Fukui to complete his term, which ends in March 2008, the uncertainty could cause a delay in the BOJ policy and continued selling pressure on the yen.

Declines in the yen should be limited as Japan’s retail sales unexpectedly rose 0.1% in May from a year earlier. Also, the BOJ Tankan survey (set to be released July 3, 2006) will likely show the nation’s biggest companies may say they plan to increase spending by 9% this year, three times the rate they forecast in March. The world’s second-largest economy grew at an annualized 3.1% in the first quarter, and employment is improving.

With or without Fukui, the Bank of Japan will likely begin to hike interest rates in July.  The Japanese economy looks to continue its longest expansion since World War II, and the deflation that started in November 1998, is finally over. Once the Fukui talk blows over, the fundamental story of the yen will again take over; and that fundamental story is very positive.

The kiwi slumped back below 0.60 last night to its lowest in more than two years, after a report showed the trade gap unexpectedly widened. Chuck has continuously warned investors of the risks the large trade deficits bring to this currency. The trade deficit was NZ$104 million in May, from a revised NZ$38 million in April. Economists have expected a surplus. As Chuck has pointed out several times in the past year, look for any short-term rally in the kiwi as an opportunity to move the investments into a more favorable currency.

Currencies today: A$ .7297, kiwi .5964, C$ .8895, euro 1.2565, sterling 1.8211, Swiss .8040, ISK 76.48, rand 7.2690, krone 6.2932, forint 223.14, zloty 3.2442, koruna 22.6635, yen 116.26, baht 38.43, sing 1.5979, INR 46.39, China 7.9984, pesos 11.41, dollar index 86.58, silver $10.36, and gold $583.85

That’s it for today. Happy birthday to Alex Butler! I still remember the morning over 11 years ago when Chuck let me know about his and Kathy’s little surprise blessing. I hope Chuck and Alex have a great breakfast at MCD’s, and that everyone has a great wired Wednesday! Now, where is Christine with the Starbucks??

Chris Gaffney
June 28, 2006

The Daily Reckoning