Waiting on the FOMC

Good day. Hope everyone had a great weekend.  The weather here cooled off a little, so mine was terrific. The currency markets were hot Friday, as the jobs data disappointed, and traders increased bets that the FOMC will pause at tomorrow’s meeting. No real data out today, so the market has backed down a bit in preparation for the interest-rate announcement.

As Chuck told you Friday morning, the markets were prepared for an increase of 144,000 jobs in July, but the actual jobs number came in at only a 113,000 increase. The unemployment rate increased slightly to 4.8%, and the change in manufacturing payrolls fell a surprising 15,000 compared to an expected increase of 5,000. This data took the Euro from just below 1.28 all the way up to 1.2909 before it backed back down below 1.29, and the rest of the currencies followed the Euros lead.

Today, we will see consumer credit for June, which is expected to come in at 3.6 billion, down slightly from May’s number. Tuesday is the day the markets will be focusing on, as we will see if Bernanke and the boys will pause or give us one more rate increase. Many traders now feel the data shows that Bernanke may have waited too long to pause, while others believe we will get one more increase before the end of rate hikes. Housing, consumer spending on durable goods, and corporate outlays on equipment all contracted last quarter for the first time in 15 years as interest rates and oil prices rose. And we still haven’t felt the full effect of the Fed’s 17 previous rate increases. So, I’m now siding with Chuck on this one and believe the FOMC will decide to pause (better late than never).

I read excerpts from PIMCO’s latest market outlook over the weekend, and Bill Gross, who manages the record $93-billion total return fund, says the dollar will continue to slide. Investors will seek rising yields in Europe and Japan, Pimco said in its latest market outlook. A decline in the dollar is also needed to narrow the U.S. trade deficit by reducing the nation’s imports from Asia, the release said, after the gap widened to a record in October. “The end of Fed tightening could result in flows of capital out of the dollar,” the report said. “Pimco will likely take positions in the yen, emerging-market currencies, and the euro to hedge against dollar weakness.” Hopefully readers of the Daily Pfennig have already taken these positions since Chuck has been saying the same thing for a while now. It is nice to be able to purchase in front of a market monster like Pimco!

With the U.S. markets are likely taking a short breather today, currency traders focused on the data released in Europe for direction. German retail sales grew for a fourth month in July as unemployment fell and consumers brought forward purchases to avoid an increase in sales tax next year according to the Bloomberg purchasing managers index.  The index stood at 54.2, the fifth highest level since it was first compiled in January 2004. After raising rates last week, the ECB members continue to sound like additional rate hikes will be needed. ECB council member Klaus Liebscher said the bank is ready to raise interest rates further to keep faster economic growth and near-record oil prices from spurring inflation. “Upward risks to price stability haven’t receded but rather worsened,” Liebscher said in an interview. We still look for the ECB to continue to raise rates, narrowing the interest rate spread the U.S. had enjoyed over European rates. This “yield advantage reversal” will continue to drive the U.S. dollar down versus the euro and yen during the remainder of the year.

Japan’s broadest index of future economic activity showed the current expansion will probably become the longest in the postwar era. And the month of August has traditionally been the best month to buy the yen since 1991, according to data compiled by Merrill Lynch and Company. The yen gained an average of three percent during this month, over the past eight years. It typically advances against the dollars as Japan’s investors, the largest international holders of U.S. Treasuries, receive semi-annual interest-rate payments from the U.S. government. With the yen up versus the U.S. dollar just over 2.35% this year compared to 8.46% for the euro, and over 10.5% for the pound sterling, the Japanese currency certainly looks undervalued. After the U.S. Fed pauses, we could see a major move for the yen as the Bank of Japan continues to increase rates.

Finally, the Chinese adjusted the renminbi again, letting it come up in value to match the other Asian currencies. While they have avoided major adjustments of the renminbi, the Chinese continue to let it move up versus the U.S. dollar at a fairly steady pace. Look for them to continue to match any upward moves by their Asian competitors currencies.

Currencies today: A$ .7626, kiwi .6234, C$ .8893, euro 1.2858, sterling 1.9081, Swiss .8178, ISK 70.30, rand 6.8058, krone 6.1318, SEK 7.138, forint 209.82, zloty 3.00, koruna 21.97, yen 114.91, baht 37.72, sing 1.5730, INR 46.57, China 7.968, pesos 10.91, dollar index 84.63, silver $12.40, and gold $648.77

That’s it for today. Chuck is off on his annual summer trip down to southwestern Missouri. I sure hope the heat and humidity stays away for him and his family. Today should be a fairly quiet day as the markets prepare for tomorrow’s FOMC release. Hope everyone has a great start to their week.

Chris Gaffney
August 7, 2006