A Pfennig For Your Thoughts

Chris Gaffney is temporarily filling in for Chuck Butler

In this issue…

  • Trichet’s day
  • Canada’s Juiced Economy
  • Trouble for Japan
  • Slow and steady from China

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And Now… Today’s Pfennig!

Trichet’s day

Good day… The day the currency markets have been waiting for is finally here. The European Central Bank will announce its interest rate increase. While most traders believe a .25% hike is in store, the focus will be on the press conference of the ECB’s president Jean-Claude Trichet which should occur about 15 minutes after the rate announcement. The markets will be looking for any signs from Trichet regarding the possibility of future rate increases. If the ECB raises just .25% and Trichet indicates that there will not be a need for further increases in the near term, the US$ could get some legs again and the Euro could fall back to 1.16 or worse. But, if the ECB raises .25% and indicates a need for future increases, we expect the Euro to move back above the 1.18 figure. Of course, if the ECB steps up to the plate and makes an unexpected move of .5% as we have suggested earlier this week, the Euro could test 1.20 again. We will just have to wait to see just what the Frenchman has in store for us.

We saw more good data released in the US yesterday. Under normal circumstances, the announcement that both GDP and personal consumption was above 4% would have given the dollar some real strength. But as I said yesterday, the currency markets seem to want a reason to take the dollar lower so they are awaiting the ECB rate announcement. Not many currency traders want to be short the Euro vs. the US$ this close to a possible rate hike. Look for more good data out this morning in the US as we will get the personal spending number, PCE deflator, weekly jobs data, construction spending, ISM manufacturing, and vehicle sales. I think this is the largest data release day that I have ever seen! The economists are expecting this data to reflect low inflation and slower job growth in the US. But even with all of this data, the currency markets direction will be set by the rate announcement of the ECB.

Chuck left me another email last night with these thoughts on the Canadian economy:

“We have received two very strong pieces of data from Canada this week, which continues to be the belle of the ball… First of all, does anyone recall when I wrote about Canada’s economy being “juiced” by energy & coal?

Well… The 3rd QTR current account SURPLUS widened slightly more than expected to C$9.3 Billion (consensus C$9 Billion), with an upward revised C$4.9 Billion in September (prior C$4.7 Billion). As expected, energy prices drove the widening of the surplus as they have the widening of the merchandise trade surplus. Natural gas prices recorded a 30% growth in the quarter, mostly following the effect on natural gas capacity from Katrina.

Great stuff eh?… Well, how about this bit o’news?… Canadian GDP accelerated to 3.6%,from an upward revised 3.4% in 2nd QTR. Growth came from a rebound business investments and net exports. Business investment accelerated to 8.7% from 5.7%. And you know how well a country is growing internally when there is Business Investment!!!!

So… The future’s so bright for Canada, I’ve gotta wear shades!”

Chuck has been a fan of the great white north for some time, and the loonie hasn’t disappointed ranking second only to Mexican Pesos in returns vs. the US$ so far this year. Those of you who need more of a Chuck Butler fix can find an excellent article in the latest edition of ‘What We Now Know’ from Casey Research. In it, Chuck details his top five reasons the US$ will weaken in the coming months. You can find the newsletter at www.caseyresearch.com, just scroll down to the What We Now Know link and subscribe for free!

While the Euro/$ exchange rate has been holding steady in spite of the US data, the Yen has been taking on the chin. Last night the Yen slid over the 120 level for the first time since 2003. Traders are now questioning whether Japan will be able to start raising rates and with the FOMC expected to continue their tightening, interest rate differentials look to widen. Long term readers know that I am a fan of the Economist magazine, and Buttonwood has an excellent column in this weeks issue discussing the spat between Japan’s government and its central bank. The article points out how the recent frictions between the politicians of the government and the economists of the BOJ have led to more uncertainty and therefore weakness in the Yen.

It now looks like it will be well into 2006 before rates move above the current near zero level. If you own Yen and have the patience to wait until rates start to move back up, I think you will be handsomely rewarded. If you don’t have the patience to wait, you may want to take advantage of any strength in the Yen to move your investment back into the commodity currencies of AUD or NZD. Those of you with the Asian Advantage Index CD already own the NZD, so hold on to your positions as the NZD has offset most of the weakness of the Yen in this cd. When the Bank of Japan finally does move rates, these Asian Advantage CDs should be one of the best performers.

Finally a quick note on China. Earlier this week the US government declined to name China a currency manipulator and said the Asian nation must give the markets an even greater role in setting exchange rates to avoid such a charge in the future. We all know that China has definitely manipulated their currency to help build exports, but the administration seems to scared to call them on it. As expected, several in congress called for stronger action from the administration, but they had better be careful of what they are asking for. As we have discussed in past pfennigs, if China were to revalue their currency overnight, it would only have a minimal impact on the trade surplus. It would, however, have a dramatic impact on the US treasury market. You see, if and when China stops keeping their currency so closely linked with the US$, they will dramatically reduce the amount of US treasuries which they need to purchase. As they are one of the largest holders of US debt, a reduction of their holdings would certainly raise interest rates here in the US and possibly send the economy into a tailspin.

For now, I think the current policy of letting China slowly revalue their currency is a good one. They have linked the currency to a basket including the Yen and Euro, so as they continue to slowly revalue, these two currencies should also appreciate vs. the US$. Those investors looking to make a quick buck on China’s revalue will be disappointed, but the currency is likely to continue a steady climb upward. In fact, earlier this week the Renminbi was quoted at an unprecedented high of 7.9997 to the dollar at some of China’s local banks. This would certainly indicate that the official peg rate will be working its way down below 8.0 sometime in the future.

Currencies today: A$ .7408, kiwi .7047, C$ .8570, euro 1.1770, sterling 1.7303, Swiss .7605, ISK 63.41, rand 6.4691, krone 6.7821, forint 215.46, zloty 3.33, koruna 24.617, yen 120.16, baht 41.24, sing 1.6897, China 8.0798, pesos 10.56, and gold… $497.51

That’s it for today… The ECB has made their announcement of a .25% increase so now we will wait to see what Trichet has to say about future increases. Should be a volatile and busy day in the currency markets. Hope everyone has a fun Thursday!

Chris Gaffney, CFA
Vice President
EverBank World Markets