When Doves Fly

Good day… No, I’m not talking about an 80’s song… I’m talking about the Fed Reserve statement yesterday that followed yet another month of unchanged rates. I’ve got that and some data from Euroland to talk about today, so let’s not delay any longer!

First and foremost, the Fed Reserve left rates unchanged yesterday, for the fourth consecutive FOMC meeting. That wasn’t so surprising… What was surprising was the “dovish” tone the Fed took in explaining their (non) action. Let’s see what they had to say, eh?

The Federal Reserve acknowledged that a “substantial cooling of the housing market” is underway. This is more aggressive terminology than in the previous statement, which merely characterized the housing market as having “cooled.” The markets haven’t quite figured this one out yet… But to me it’s as clear as the nose on my face. (OK, I watched my favorite movie the other night, The Wizard of Oz. So if the “Oz” quotes keep popping up, you know why!)

The Fed has laid the groundwork for a rate cut next year… They are talking about the “substantial cooling of the housing market” which is Central Bank parlance for “the economy is slowing by leaps and bounds”! And when an economy hits the brakes like the United States is going to do in 2007, interest rate cuts will follow. Inflation is still taking liberties with our disposable income, but don’t let that get in the way of a “Fed to the rescue” story! This is big time stuff folks… The Fed doesn’t just change the wording this significantly willy nilly… They have motives and reasons for doing so, and the quicker the rest of the markets pick this up… The quicker the dollar will get sent to the woodshed and stay there.

OK… The U.S. trade deficit in October narrowed to an astounding $58.9 billion, and should have put some strong wind in the dollar’s sails. Unfortunately, the deficit narrowing didn’t have any teeth to it, as the narrowing was all due to an 18% drop in oil imports…18%! WOW! Now we all know that isn’t going to last… And for once… The markets saw that too, and instead of the dollar rallying, the currencies took the ball and went in for a lay-up.

This morning, we’ll see November’s retail sales in the United States, and when you take into consideration all the discounts that retailers were selling items at after Thanksgiving, this report should be off the charts! However, I’m not buying that. Using the Butler Household Index… I’m going to say that retail sales did bounce off the negative 0.4% in October, but not to the tune that the pundits are talking about. Still… The dollar could get some love on the data.

In the United Kingdom this morning, the rate hike friendly data just keeps coming! Yesterday, you may recall that inflation hit a decade high of 2.7%… And today, unemployment unexpectedly dropped by the most in two years! So pound sterling is back on the warpath to the “two” level. With the labor market heating up, wage pressures will push that decade high inflation rate even higher. To beat it back down, the Bank of England needs to hike rates, which will allow the pound sterling to get even stronger… And we all know that a strong currency goes a long way toward fighting inflation!

Data from the IMM suggests that currency investors are still very short of the yen, which means “carry trades” are still the cat’s meow. Yen is just not receiving any love from the markets, and it’s being tarred with the same brush that’s being used to paint the dollar. What are the “carry trade” guys going to do when the Fed does cut rates in 2007, and the Bank of Japan continues their newly formed rate hike cycle?

Consumer confidence is on the rebound in Australia according to the latest report, which follows last week’s strong employment report. Australia has it all going on… Raw materials and base metals still in demand from China… Strong yields… Good Show!

I read stuff from dealers, economists, and market observers all the time… And more and more people are jumping on my Sweden / Norway/ Switzerland / euro bandwagon. I just wish these “guys” would give credit where it is due, and tell people that EverBank has a basket CD that contains each of those currencies! Now THAT would be the horse of a different color!

Seriously though… These currencies have been the stars of 2006… Along with the Thai baht… And pound sterling.

The dynamic duo of Paulson and Bernanke is due to arrive in China today, and guess what the Chinese allowed the renminbi to do today? Give up? Aw, come on. If you’d paid attention in class this would be as easy as the $100 question on “Who Wants to be a Millionaire!” Yes… They allowed the renminbi to gain more than the 0.3% versus the dollar. This has happened every time a Treasury Sec. or lawmaker has visited China. The Chinese show them that greater flexibility is in the cards, the visitors leave thinking they “swayed” the Chinese, and then the Chinese currency policy returns to normal!

These two knuckleheads just don’t get it… We keep wasting money on boondoggles to China… And for what? To see the renminbi gain 5% versus the dollar since the drop of the peg. Five percent when talking about the renminbi is like removing a bucket of sand from the beach. Who notices?

OK… Maybe I was a little hard on the Beaver/knuckleheads… And maybe they have something up their collective sleeves that will get the Chinese to allow greater flexibility. Maybe… Just maybe.

I’m kind of hoping they do get what they want… Because, then they will have to live with the fact that the dollar is dropped like a bad habit, and the U.S. economy gets brought to its knees from the increased costs at Wal-Mart, etc. As I’ve said many times in the past… Just leave the Chinese alone!

Currencies today: A$ .7895, kiwi .6923, C$ .8690, euro 1.3275, sterling 1.9730, Swiss .8325, ISK 69.20, rand 6.9990, krone 6.1350, SEK 6.81, forint 191, zloty 2.86, koruna 21, yen 117, baht 35.22, sing 1.5380, HKD 7.7720, INR 44.78, China 7.8265, pesos 10.84, dollar index 83.01, Silver $13.80, and Gold… $628.55

That’s it for today… Sitting here typing away, listening to my favorite Christmas CD. It has Ann Margaret singing “Baby it’s Cold”… And a favorite of the desk… James Brown’s “Soulful Christmas Tree.” Great Stuff! Only 11 shopping days left! I haven’t bought one present yet! OK, Chuck, settle down, that’s what next week is for! Mr. Gaffney will grace us with his presence today (he was out yesterday), and hopefully he comes bearing gifts for Wired Wednesday! Have a great Wednesday!

Chuck Butler
December 13, 2006

The Daily Reckoning