Waiting For The GDP

Good day. The dollar continued its slide yesterday, as a positive durable-goods report was offset with falling new home sales (seems like I remember somebody saying that would happen). Today we will get the most important numbers, with GDP, personal consumption, core PCE (the feds favorite measure of inflation), employment cost index, and the University of Michigan confidence number. So, look for some excitement later this morning; the European markets have rallied the dollar going into these numbers, so we could see some volatility.

As I mentioned in the opening paragraph, orders for durable goods rose more than forecast in June, and May’s numbers were revised from negative to positive. The 3.1% jump in orders for goods made to last at least three months followed a revised gain of 0.3% the month before. While this number started the dollar up, it quickly turned around as home sales were reported about an hour and a half later. New home sales in the United States fell three percent in June. And with the inventory of new homes available for sale at record levels, we will likely see builders continue to cut prices. The median price rose just 2.3% from a year ago, the smallest increase since December 2003. Looks like the housing bubble is definitely beginning to deflate!

The European markets have moved the dollar up versus most of the currencies this morning as they are predicting the GDP and labor costs in the second quarter will show a strong economy with accelerating inflation. I believe the old saying of “buy the rumor and sell the fact” will come true with regards to the dollar today. While GDP will be positive, I can’t see the number coming in strong enough to offset the beige book predictions of a slowing economy. Any number of 3.5% or less will cause the dollar to sell off. The consensus estimate is for growth of 3% in the second quarter following a strong 5.6% GDP in the first quarter of 2006.

The most important number being released today is the core personal consumption price index. This is the gauge of inflation, which the Fed most closely monitors. It is expected to have increased from last quarters 2.0% to 2.9%. This would be the largest quarter-on-quarter increase since 1992. If this core deflator does rise, it could give traders reason to buy U.S. dollars, as the bets on additional FOMC tightening would increase. The employment cost index is also expected to show an increase, adding to the possibility of another rate hike.

No matter what the numbers show, I think the beige book released earlier this week best shows what the U.S. economy has in store for the rest of the year. The big picture shows a U.S. economy that is slowing in consumer spending and a housing market that is cooling off. That will carry through to weaken growth in the second half. That is basically what Chairman Bernanke said last week. While oil prices will continue to push inflation, the FOMC will have to measure the risk of this inflation with a slowing U.S. economy.

In Chuck’s presentations, he speaks of the props holding up the U.S. dollar. One of those props has been the U.S. housing market, which has provided consumers with the ability to generate spending without increasing income. I think we all agree that this prop is being slowly pulled out. Another prop for the U.S. dollar has been the interest rate differentials in the United States has enjoyed. With the end of the tightening by the FOMC, this second prop will be kicked out from under the dollar. Needless to say, we think the U.S. dollar is in for a hard landing.

Turning to Europe, money-supply growth in the dozen nations sharing the euro slowed in June from the fastest pace in more than three years, after the ECB raised interest rates in an attempt to rein in inflation. M3, the ECB’s preferred measure of money supply, rose an annual 8.5% after a revised 8.8% in May. While this number was down, the slower pace is unlikely to keep the policy makers from lifting the benchmark lending rate next week as oil prices keep inflation above the central bank’s limit. I find it interesting that the ECB’s number-one gauge of inflation is the M3 numbers. As long time readers know, the U.S. decided to quit announcing the M3 numbers, as they said nobody paid any attention to them. It just calls into question a FOMC that ignores data the ECB uses as their top inflation gauge!

The pound sterling has been one of the best performing currencies this week, as reports continue to show an economy that is growing. A survey yesterday showed factory orders in Britain rose to the highest in three months in July. Traders have increased bets the Bank of England will increase interest rates this year, future prices show. You will remember there were several currency traders who were predicting a lowering of rates earlier this year, so the turn around should continue to give strength to the pound.

Iceland’s krona, the world’s second-worst performing currency this year, headed for its longest winning streak since Fitch Ratings cut its outlook for the country’s debt in February. The currency is set to gain for a fifth week, which is its best winning run this year. There is a positive outlook for the krona, as the current account deficit declines. It is also helped by a fall in consumption. The krona has surged more than six percent since sliding 17 percent to a three-year low on April 21, 2006. Iceland’s finance minister forecasts further narrowing of the trade gap as Alcoa starts up production at recently constructed aluminum mills. Exports of aluminum should help reduce the deficit to about two percent of GDP by 2010 from a forecasted gap of 8.6% next year. It is interesting that the major turmoil for the currency was a result of the aluminum investment and it will now get its return as exports rise. This currency will continue to be volatile, and should only be purchased by individuals looking for speculation.

Currencies today: A$ .7640, kiwi .6148, C$ .8826, euro 1.2729, sterling 1.8625, Swiss .8094, ISK 72.91, rand 6.933, krone 6.21, SEK 7.29, forint 213.98, zloty 3.10, koruna 22.48, yen 115.08, baht 37.94, sing 1.5848, INR 46.68, China 7.9705, pesos 10.92, dollar index 85.95, silver $11.33, and gold $628.96

That’s it for today. Got to cut this one a little short, as the numbers are coming out shortly. Big announcement on the desk yesterday as our little Christine told us she is expecting her second child next year. Congratulations, Christine! Chuck is heading back to the states this weekend, but I will still be bringing the Pfennig to you for another day, as he will be out Monday. Hope everyone has a profitable Friday and a great weekend.

Chris Gaffney
July 28, 2006

The Daily Reckoning