A Pfennig For Your Thoughts

In This Issue…

  • Jobs Jamboree
  • Euro strength
  • Aussie stars
  • Loonie loses

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And Now… Today’s Pfennig!

Jobs Jamboree

Good day… All eyes will be focused on the payroll data due out this morning. We will get the change in nonfarm payrolls, unemployment rate, change in manufacturing payrolls, average hourly earnings and average weekly hours for December. Positive reports may give the Federal Reserve more reason to continue raising rates; a policy that is largely responsible for driving the dollar up vs. most of the currencies in 2005. As Chuck reported earlier this week, the minutes of the last FOMC meeting said the number of future rate increases “probably would not be large,” causing the biggest weekly drop in the dollar in more than a year. Traders will be analyzing the data due out this morning to try and predict just how much longer the Fed will be raising rates.

Any sell-off in the currencies due to strong payroll data should be viewed as an opportunity to buy currency at cheaper levels. If you take a step back and look at the longer-term picture instead of the day-to-day fluctuations, you will see why we are so confident the dollar will resume its downward spiral in 2006. Economists are debating exactly when the FOMC will stop raising rates, notice I said when, not if. There is no question that rates in the U.S. are nearing the top of this cycle while the Eurozone has just started raising rates, and Japan is looking to begin raising rates sometime in 2006. Interest rate differentials are what drove the dollar up in 2005, so the reversal of these rate differentials in 2006 should bring the dollar back down. Of course, there are several other factors that will affect the value of the U.S. dollar during 2006 (current account deficits, budget deficits, Asian central bank diversification of reserves), but I don’t see any of them coming in on the side of the dollar bulls.

A report released today showed industrial production in Germany rose by the most in more than five years from a year ago. This report caps a week of reports that suggest euro-region growth is gathering pace. European consumer confidence last month rose to the highest in more than five years, German unemployment fell the most in more than a decade and service industries grew at the fastest pace in almost two years, reports showed this week. Data like this will force the ECB to get more aggressive with interest rate increases, just as the U.S. interest rates are ending their rise. While the 2% advance of the Euro this week is probably a little too fast, we think investors should look for any pullback to begin taking positions.

While the rest of the commodity currencies continue to rise, the Canadian dollar lost almost 1.2 percent yesterday, the most in more than six months. The main reason for this selloff seems to be a government report that showed the economy unexpectedly lost jobs last month. This report may temper expectations about how much more the central bank will raise interest rates this year. A sell-off in the price of natural gas and a drop in copper and gold also helped to bring the currency down. Despite this temporary sell-off, we still believe the central bank will continue raising rates at its next meeting Jan. 24 and that commodity prices will stabilize, keeping the loonie well bid.

A star of the commodity-based currencies recently has been the Australian dollar. The Aussie headed for its biggest weekly advance since June as investors bet the country’s interest rate advantage will hold. Asia will continue to be the world’s growth engine, and Australia will continue to feed them the commodities they demand. We believe you will see the Australian dollar rise to 78 cents by the end of the first quarter and possibly 80 cents by mid-year.

Chuck touched on a story yesterday that I think will be one of the major factors of the dollar’s fall in 2006. China’s plan to seek higher returns on its record foreign-exchange reserves should have a major impact on the value of the US$. China’s reserves swelled to a record $769 billion in September, second only to Japan’s, as the central bank bought dollars to limit gains in the Renminbi. Investors in China now hold more U.S. Treasury notes than any other foreign country except Japan. As European interest rates rise, look for China to start diversifying these holdings away from the dollar. But the European currencies will not be the only ones to benefit from this move. Look for China to continue to invest in other assets including gold, silver, platinum, and non-traditional reserve assets like their investment into oil sands in Canada. As Chuck stated yesterday, we will continue to watch this developing story.

Currencies today: A$ .7475, kiwi .6855, C$ .8546, euro 1.2103, sterling 1.7565, Swiss .7831, ISK 61.17, rand 6.15, krone 6.5529, forint 207.05, zloty 3.14, koruna 23.88, yen 115.94, baht 40.06, sing 1.6450, China 8.066, pesos 10.64, dollar index 89.44, and gold… $529.02

That’s it for today… I have got to cut this a little short as both Chuck and Christine are gone, so I got to get to work. Hope everyone has a terrific weekend!

Chris Gaffney, CFA
Vice President
EverBank World Markets