A Pfennig For Your Thoughts

In This Issue…

  • Inflation good for a currency?
  • Fed not so sure anymore…
  • An explanation of the Iceland story…
  • Kiwi demand wanes…


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And Now… Today’s Pfennig!

Would Everyone Please Calm Down?

Good day… Well… I’ve got more of the skinny on the Fitch ratings outlook for Iceland… In fact, John Kaupisch and Chris Gaffney did so much research on this yesterday that I’m loaded for bear this morning! In addition, we have the FOMC meeting minutes to go over, and the daily direction of the currencies… So, with no further delay…

First of all… The dollar is swinging a big hammer again this morning on thoughts that, (now get this, and see if the heading on the news article sounds as strange to you as it did to me) “Dollar Gains vs. Euro on Speculation Report to Show Faster Inflation”… Hmmm, somewhere, maybe even in my “Exchange Rate Determination” book, it tells me that inflation is a plague that attacks a country’s currency… So… If the report is to show faster inflation, shouldn’t that be bad for the dollar? Oh well… I carry on despite the dolts!

The FOMC meeting minutes were basically the notes that Big Ben used to testify with last week when he made the trek to “the Hill” and spoke to Congress about the economy… No surprises in the minutes… There was one quote, though, that I thought worth repeating to Pfennig readers… “All” agreed the future funds rate “could no longer be pre-judged with the previous degree of confidence”. In Central Bank parlance, that means that the members of the Fed aren’t so sure about future rate hikes… I would have thought this message to also be bad for the dollar… Oh well… I carry on despite the misunderstandings…

OK… Yesterday, there was a news article that flashed across the screen as I was writing the Pfennig, regarding Iceland’s currency downgrade by Fitch, and I reported that and said I would do some additional work to find out just what was going on… I mean, the fact that very large currency desks that I deal with had no idea this was going on, really emphasized the surprise here…

However, we all just need to calm down… As opposed to the news headline… Iceland’s currency was NOT downgraded! Instead, Fitch downgraded their currency OUTLOOK, which when you go to Fitch and ask them just what that means, they will tell you…

A Rating Outlook indicates the direction a rating is likely to move over a “one- to two-year” period. A Negative Rate Outlook does NOT imply a rating change is inevitable… In other words… Fitch gives a warning, and the country can choose to do something about it… We’ve seen this similar thing with South Africa and New Zealand…

Fitch only changed the outlook for the Icelandic krona, not the actual rating. The long-term foreign and local currency issuer default ratings were affirmed at AA- and AAA, respectively. Also, I would point out that both Moody’s Investors Service and Standard & Poor’s have stable long-term outlooks on Iceland. In addition… last year’s best-performing currency, the Mexican Peso, has a lower credit rating than Iceland, so credit ratings don’t always predict a currency’s direction.

As we have been pointing out all along, the economy of Iceland is very small (just $12 billion) and therefore their currency has a small ‘float’. Sudden statements such as what happened today therefore have a much larger and dramatic impact. While the move from 63 up to 66 was dramatic, the currency was trading at 65 back in December, so this move isn’t something that can’t be reversed rather quickly.

While Iceland’s current account deficit causes concern, their economy is small enough to get this turned around rather quickly. The central bank has been raising rates, (almost doubling them since May 2004) and we look for additional increases through mid-2006. These higher interest rates should help support the currency in the near term.

Much has been written about the Icelandic economy ‘overheating’. These statements are similar to the hot air that blasts out of Iceland’s ground. In fact, the central bank has been proactive in reigning in inflation, which peaked at 4.8% in September and is now expected to slow to 3.3% this year. The high interest rates have also slowed economic growth from 6.6% in 2005 to an expected level of 4.7% this year. The Nordic nation’s trade deficit has also narrowed to 9.4 billion krona in December from 11.2 billion krona a month earlier. If 4.7% growth, a narrowing trade deficit, and 3.3% inflation in Iceland is overheating, I would love to see what Fitch thinks about the Chinese economy!

So… Yesterday’s price action might have been ugly… It also gave tons of new buyers an excellent buying opportunity… And… There should not be any Chicken Littles running about in Iceland… But as I’ve said every time I’ve talked about Iceland in the past… This is a small economy, and therefore is subject to wild swings… And I see where it has lost even more ground overnight… Wild swings, which haven’t really been prevalent with this currency in the past couple of years, but have returned now…

The New Zealand dollar continues to lose ground vs. the greenback… It seems that the Uridashi bond issuances have slowed to a trickle and that demand for the currency is waning… I told you this would happen, once demand slowed… I just don’t see any light at the end of the tunnel for the kiwi… And if you have listened to me for the past 5 months and closed your kiwi CD’s when they came due, and moved to another currency, you’re looking good… And always, I tell you my friend, it is better to look good than it is to feel good! No, wait! I was being serious there, and the next thing I know, my fingers were typing and I had no control over them… It’s the Chuck’s Evil Twin syndrome!

OK, I’m back now… I was gone for a minute there, but I’m back! What were we talking about? Oh, that’s right, kiwi… Please don’t go breaking CD’s… If you have a month to go until maturity, why not call EverBank and ask how to “hedge” your currency risk? Go ahead, the 800# to the trading desk is below!

Currencies today: A$ .7365, kiwi .6580, C$ .8710, euro 1.1885, sterling 1.7410, Swiss .7620, ISK 67.90, rand 6.13, krone 6.79, forint 213.20, zloty 3.20, koruna 24, yen 118.70, baht 39.45, sing 1.6325, China 8.0475, pesos 10.53, dollar index 90.77, silver $9.5350, and gold… $552.45

That’s it for today… CPI report today… I just shake my head and wonder… I’m in the middle of reading Dr. Richebacher’s latest letter… He really is going after Bernanke, so I’ve got to finish it fast! Former Fed Chairman (and a real Central Banker) Paul Volcker once said that he thought it to be a Fed chairman’s job to prove Dr. Richebacher wrong… Well… I want to see Bernanke do just that, because Dr. Richebacher is not high on the U.S. economy, calling it the U.S. Bubble Economy! So, on that uplifting note… Have a great “Wired Wednesday”!

Chuck Butler
EverBank World Markets