Will The Fed Pause In June?

Good day. And a Happy Friday to one and all! I sure do like these four-day workweeks, not that I have anything against work. It’s just that things seem to flow better in four days versus five. So, do you think I could get the “boss” to shut-r-down every Monday? Yeah, right! Oh well, I carry on.

OK. One day we see the dollar rally on what I believed was bad fruit in the FOMC meeting minutes. The next day (yesterday), we see the currencies rally on some weakened ISM and productivity data. Crazy…Crazy for thinking about you – OK, now is not the time or place for Patsy!

But seriously, this back-and-forth range-trading hinging on each new day’s data is really beginning to give me a rash! I read a story on the Bloomie this morning that was written by John Berry, the former Fed Reserve member that contributes stories to Bloomberg all the time. This stuff that he writes about is pretty technical, but I’ll walk you through it when he’s finished. I think what he’s pointing out is very important!

“According to the May minutes, officials noted that alternative measures of labor compensation’ provided divergent readings. After yesterday’s revisions, there’s no divergence. A jump in unit labor costs at a 3% annual rate in the 4th QTR of last year at non-farm businesses turned into a decline of 0.6% in the new figures from the Labor Department. Similarly, the 1st QTR’s increase at a 2.5% rate was toned down to a 1.6% rate.

“Estimates of compensation increases for both quarters were lowered and the productivity gain for the 1st QTR was revised up. The changes left compensation only 2.8% higher than it was in March 2005, and unit labor costs up only 0.3% over the same 12 months. Hardly fuel for a sustained increase in inflation.”

OK. Basically, Mr. Berry is pointing out that the revisions to previous data that the Fed was worried about removes the worry. It gives the Fed an excellent opportunity to pause later this month at their FOMC meeting. Of course, this is his opinion, but I lean that way, too. A pause in interest rate hikes is just what the doctor ordered to push the euro back to 1.30 on its way to its previous highs versus the dollar!

Now back at the ranch. The currencies rallied versus the dollar yesterday, wiping out the dollar’s gain the day before. And it all came from a surprisingly lower ISM manufacturing index figure. The May ISM index came in at 54.4. It was lower than expected, with the “experts” forecasting a 56.2 figure. The dip in the May ISM index indicates that manufacturing activity remains above the “50” level, which indicates expansion. However, this “expansion” is at a slower pace than earlier this year. The May reading was the lowest since June of 2005.

In addition, the employment index slowed to 52.9 from 55.8. And here’s a piece of the report that few ever take the time to explore. The more forward-looking components of the report – backlog of orders and new orders – declined, and is on the edge of falling below the “50” level, which doesn’t spell good things for manufacturing going forward.

OK. I won’t bore you with any further discussion of the “data” from yesterday! However, all could be turned on a dime again this morning, when the Jobs Jamboree figures are printed! Right now, the “experts” believe that that we created 170,000 new jobs in May. Anything greater than that forecasted should be dollar friendly, and anything less than the forecast will be dollar negative.

Of course, I can’t let a Jobs Jamboree pass each month without stepping up on the soapbox and pounding my fist to tell you that the number of jobs created doesn’t amount to a hill of beans unless we know what “type of jobs” they were. So, to really get anything out of the Jobs Jamboree, one must look to the average hourly earnings and the average weekly hours for any indication of wage pressures on inflation. I just haven’t seen any wage pressures in either of these two reports.

However, I can tell the markets are champing at the bit to see wuz up with the Jobs Jamboree. It will dictate both how the currencies trade today and end the week.

Next week, we’ll get to the ECB’s interest-rate meeting, at which they will raise rates. But as I told you the other day, the ECB has started a whispering campaign for a 50-BPS rate hike. They threw it out there to see how the markets reacted to it, and so far, so good. So, now we are at the 50/50 table regarding whether they will hike 25 or 50 BPS next week. While I believe a 50-BPS hike would give the euro more of a boost than the expected 25-BPS hike, the press conference afterward will be even more important.

I haven’t talked about China all week, so here goes! The People’s Bank of China’s quarterly policy statement had some interesting things in it. The most important of course is the statement that they (the People’s Bank of China) would start lowering the “frequency and strength” of its actions in the currency markets. That means, on paper mind you, that they will stop manipulating the currency so much. And the currency would see a “swifter appreciation” versus the dollar. Well, that’s all fine and dandy if they actually do remove their hand from the cookie jar. But, I’m from Missouri; they are going to have to “Show Me!”

This scenario is what’s really needed to get the Asian currencies moving versus the dollar. We’re just not seeing the Asian currencies take off versus the dollar – even with all the great economic fundamentals they have going for them. And quite frankly, this non-move by the Asian currencies versus the dollar is not what’s good for the global imbalances. We’ve got to get these “guys” going!

And the longer the Asian currencies don’t make gains to correct the global imbalances, the more likely it is that we’ll see the IMF, with their new responsibilities handed to them from the G-7, begin to step up pressure on China. I foresee a lot of saber rattling from the IMF. But remember one important thing, China wants very badly to be a part of the WTO (World Trade Organization), and the IMF could use that as the carrot.

Currencies today: A$ .7490, kiwi .6280, C$ .9070, euro 1.2820, sterling 1.8675, Swiss .82, ISK 71.60, rand 6.66, krone 6.0666, forint 204.50, zloty 3.06, koruna 22.02, yen 112.75, baht 38.15, sing 1.5775, INR 45.91, China 8.0235, pesos 11.25, dollar index 84.67, silver $12.19, and gold $631.40

That’s it for today. We saw some major storms pull through our area yesterday. The little creek at the back of my property was a raging river! Onto the weekend! Cards play the Cubs tonight. I’ll be there! Lots of graduation parties to attend, as all the neighborhood “kids” have all grown up and are headed to college! June has my anniversary (30 this year) and my little buddy’s birthday, so we’ve got that going for us, eh? Have a great Friday and weekend. Now, onto that Friday morning latte’!

Chuck Butler
June 2, 2006

The Daily Reckoning