A Pfennig For Your Thoughts

In This Issue…

  • May day
  • April rains on the US$
  • Aussie dollar rallies
  • Yen moves up

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And Now… Today’s Pfennig!

May day…

Good day…And welcome to May. I kind of hate to see April leave us! The currencies had by far their best month in a year and a half, the metals continued their meteoric rise, and the Cardinal’s Albert Pujols set a major league record for home runs in April. Not a bad month at all. But we can’t live in the past, so what will May bring us?

Many of the currency markets are on holiday today, but here in the U.S. we will see the Personal Income/Spending data along with Construction Spending and ISM data. Tuesday we get a look at the strength of the U.S. consumer with the release of Pending Home Sales, Vehicle Sales, and ABC Consumer Confidence. Wednesday will bring us Factory Orders, MBA Mortgage Apps, and ISM Non-manufacturing data. Thursday we get the Nonfarm Productivity, and weekly jobs data. And finally, on Friday we will get the monthly jobs data along with consumer credit for March.

But with the market sentiment lately, does this data even matter? On Friday, the U.S. released a report which showed the U.S. economy grew at an annual pace of 4.8 percent in the first quarter, the fastest in more than two years. The currency markets are now ignoring all data, which could indicate additional rate increases from the FOMC after next week. While we agree with the direction the markets have been moving the dollar; when we start seeing the market ignore data, it usually means there is ‘irrational exuberance’ (to borrow a phrase from big Al). I am not suggesting that we are going to see a reversal of these currency gains, but it certainly feels like we could get a short retrenchment in the currencies. If I am right, any strength in the US$ should be looked at as a buying opportunity, as the weak dollar trend is clearly back in play.

I was looking over some items regarding the currency markets this weekend (lots of rain here, so my kids’ baseball games were cancelled) and came across the Bank of England’s Governor Mervyn King’s testimony to the House of Commons Treasury Committee last Thursday. I had missed it last week since our own Ben Bernanke was giving his testimony at the same time, but Governor King had some great things to say about global trade imbalances and the proposals to change the role of the International Monetary Fund.

On global imbalances King had this to say: “The experience of the 1990s was undoubtedly instrumental in persuading the countries in Asia to build up very large foreign exchange reserves. But at some point this will have to come to an end. It doesn’t seem remotely sensible that even those countries would want to accumulate indefinitely larger foreign exchange reserves. I think we have got to the point now where it is pretty clear that Asia in aggregate doesn’t want to make significant further additions to its foreign exchange reserves. China has made clear that its strategy over the next 10 years is to see more growth coming from domestic demand than from net exports…”

More importantly, King also warned about the risks associated with the unwinding of these imbalances: “There are many different scenarios where you could imagine that these imbalances would unwind. They could happen gradually over ten years in fits and starts with movements of the exchange rate, not all in one go, but a gradual fall in the U.S. dollar. That is not to say that there isn’t at the same time also a significant risk of a sharp adjustment in exchange rate. What we don’t yet know is the consequences of that. We saw in the 1980s there was a very sharp fall in the dollar, which in fact did not have major consequences at least for the developed world. It is conceivable that we could get big changes in exchange rates which led to gradual adjustments of imbalances and provided that policy were to respond in parts of the world outside the United States, might well lead to a relatively stable adjustment.”

So again, we are seeing Central Bank governors predicting that we are going to see an adjustment down in the value of the US$. It seems the only thing that is being questioned is just how fast this adjustment will occur. Hopefully we will see a slow and steady decline with an orderly adjustment of the world’s economy, but the risk remains that we could see a more dramatic adjustment in the value of the US$.

As I mentioned above, April was one of the best months in recent history for the currencies. The Norwegian krone was the best performer, up 6.58% with the Australian $ following closely at +6.21% and the Swedish krona rounding out the top three at +6.04%. Both the Swiss franc and British pound were up over 5% vs. the US$. Three of our favorite currencies, the CAD$, euro, and Japanese yen were all up over 4% during the month of April. Even the NZD was up 3.64% almost matching the performance of the Thai bhat (+3.78%) and beating the Singapore dollar (+2.39%). Only two currencies were down vs. the US$ during the month of April, the Mexican peso was down 1.64% and the Icelandic krona was down 3.27%. All in all, April was an excellent month for currency investors and will hopefully be a view of things to come.

The Australian dollar rose overnight on the release of an index of Australian prices for consumer goods and services. The index rose in April for a fourth month in five as fuel, rent and health costs climbed, adding to expectations the central bank may raise interest rates as soon as this week. This gain follows a government report last week showing 1st quarter inflation accelerated to .9% from .5% in the previous quarter. The central bank, which has not moved interest rates since March 2005, will announce its decision on interest rates this Wednesday. If they do move rates up, look for the AUD$ to move strongly back toward .80 over the next few months.

Another currency benefiting from interest rate expectations is the Japanese yen. The yen rose to a six-month high against the dollar and gained versus the euro on speculation the Bank of Japan is moving closer to raising interest rates for the first time since 2000. The BOJ on April 28 lifted its projection for growth this fiscal year and said inflation will accelerate, after consumer prices climbed for a fifth month in March. We believe interest rates will begin to increase in the 3rd quarter of this year, boosting the yen to 100 by year end.

Running a little late this morning, Ty and Chuck are still in Mexico so I need to head to the big finish now:

Currencies today: A$ .7628, kiwi .6403, C$ .8973, euro 1.2682, sterling 1.8356, Swiss .8126, ISK 73.79, krone 6.1361, rand 5.9847, forint 209.65, zloty 3.07, koruna 22.61, yen 112.60, baht 37.46, sing 1.5775, INR 44.82, China 8.011, pesos 11.055, dollar index 85.88, Silver $13.95, and Gold… $659.30

That’s it for today…Chuck returns this evening, so he will be back in the saddle tomorrow. We will be leaving again on Thursday to a presentation in Atlanta and then on to Las Vegas next week. The currency markets are flying this morning! Hope everyone has a great start to their week!!

Chris Gaffney, CFA
Vice President
EverBank World Markets