Dollar Receives Some Stimulus...
Daily Pfennig

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In This Issue...

* Dollar receives some stimulus...
* G8 to support $ over the weekend...
* India surprises with a rate increase...
* BOJ likely to keep rates unchanged..

And Now... Today's Pfennig!

Dollar receives some stimulus.....

Good day... We had a pretty calm day in the markets yesterday as the dollar drifted lower vs. most of the major currencies. But when the Europeans picked up the trading overnight they all but wiped out any advances the currencies had made and the dollar is now sitting slightly higher than it was trading at this time yesterday morning. But I will get to that later; let me start this morning's Pfennig off with some comments Chuck left me on the markets as he signed off his computer last night:

"OK... So quite a few of you liked my conspiracy theories yesterday, and even a few had one of their own! This whole mess of Bernanke and Paulson finally sitting up and taking notice in June is just too much for me. I think there's got to be a story here that we don't know about... Yet!

The euro which was hovering around 1.55 yesterday as I signed off, got a lift when a different European Central Bank (ECB) member, Orphanides, followed up ECB member Stark's comments that sent the euro lower, with a different statement. Orphanides decided that it was better to come clean and tell the markets that he "can't rule out the need for more rate hikes after the July hike"... You may recall that yesterday I told you the ECB member Stark had said, "However, we are not talking about a series of rate increases."

It's not often that the ECB members sing from a different song sheet... But I like Orphanides comments, and so did the markets!

We saw the color of the Fed's Beige Book (pun intended!), yesterday... And to use just two words to describe what the Fed Heads were discussing, the two words would be: "Generally Weak"... Here's a snippet of the report from the Fed... "Comments from retailers not particularly impressive as sales "slowed further" since the last report, but we still think strong sales at discounters will boost retail sales for May"

Thanks to Chuck for sending me these comments, and as I said above, all of the information released yesterday sent the dollar lower. But the European traders reversed the dollar's course and sent it rocketing back up. So what caused this reversal? It wasn't data released in Europe. European Industrial production unexpectedly rose in April as gains in France and Italy countered weakness in Germany. No, the dollar jumped on expectations that today's release of Advance Retail Sales in the US will show an increase following last months decline.

The traders in Europe are absolutely giddy with the thought that a higher retail sales number will cause the FOMC to start raising rates. But I have two problems with this most recent turn around for the dollar. First, the Advance Retail Sales numbers haven't even been released, and could come in softer than expected. As Chuck pointed out above, the Fed's own estimations of our US economy showed it to be 'Generally Weak' and indicated a further slowdown was likely.

Second, any pick up in the retail sales in April were likely due to the stimulus checks which were distributed. These checks likely gave us a one time boost as consumers rushed out and spent them. While I sometimes question the decisions the FOMC makes, I believe they have enough brainpower to realize any uptick in May's retail sales would be the result of these stimulus checks and not a sign of an economic turnaround. Unless congress wants to continue to borrow against the future to send out more stimulus checks to everyone, this uptick in spending won't last.

So even if the May's retail sales show a slight increase, I don't believe the FOMC will react by raising interest rates in the near future. We were having a discussion on the desk about interest rate differentials yesterday, and Chuck pointed out that the Fed has never raised interest rates while unemployment was rising. The ECB will continue to increase rates, as will several other countries as global inflation continues to increase. Reading all of the recent releases by ECB council members, I expect them to raise rates three more times this year while the US FOMC will keep rates on hold.
I just don't believe Ben Bernanke will be able to move US rates up. The US economy is going to continue to weaken throughout 2008 and do you really think the FOMC is going to raise interest rates in an election year and risk pushing the economy into a recessionary abyss?

I don't think so. In fact, after taking a break and holding rates right where they are for a few months, I think there is probably a pretty good chance the FOMC comes back with a further rate cut as the US economy continues to stagnate later this year.

The US currency was also supported by speculation that finance ministers from the Group of Eight countries will make comments discouraging the currency's decline at two days of meetings starting in Osaka, Japan, tomorrow. This would play right into the conspiracy theories that the US will coordinate intervention to try and strengthen the greenback. You can bet that policy makers will be doing there best to jawbone the dollar up during the weekend's G8 meeting.

One currency which did well vs. the US dollar overnight was the Indian Rupee which benefited from a surprise rate hike... The first one in over a year! The rupee liked the sound of a rate hike and rallied. India joined Brazil, China, and Russia in raising borrowing costs. These four nations, termed BRICs by Goldman Sachs, accounted for almost half of global expansion last year. India's industrial production growth accelerated more than expected in April to 7%. This higher growth will enable the economy to withstand further rate increases which will be used to combat inflation.

While the Indian Rupee has underperformed so far this year, interest rates are expected to increase by another 75 basis points during 08. As long as the Indian government doesn't step in the currency could start making up some of the lost ground vs. the US$.

One Asian country which hasn't benefited from the higher growth rates in the region is Japan. But the latest numbers show Japan's first quarter economic growth was faster than the government initially reported. Gross domestic product expanded an annualized 4 percent in the three months ended March 31, the Cabinet Office said today in Tokyo. But don't expect the higher growth figures to stimulate the BOJ to raise rates. The Bank of Japan will likely keep rates unchanged at the end of their two day meeting which begins today. And even the risk of higher inflation due to rising oil prices will not push the BOJ to raise rates before year end. While the yen looks to have very good potential, unfortunately that potential may not be realized until the BOJ begins to raise rates.

Currencies today 6/12/08: A$ .9363, kiwi .7515, C$ .9767, euro 1.5416, sterling 1.9471, Swiss .9569, ISK 78.50, rand 7.9955, krone 5.2155, SEK 6.0754, forint 160.35, zloty 2.2024, koruna 15.8284, yen 107.69, baht 33.18, sing 1.3802, HKD 7.8090, INR 42.855, China 6.9070, pesos 10.4194, BRL 1.6401, dollar index 73.83, Oil $133.94, Silver $16.59, and Gold... $869.60

That's it for today...We have finally received some nice late spring weather here, but the thunderstorms are expected to come back tomorrow. I was saddened to hear about the tragedy which occurred just north of us with a deadly tornado hitting a boy scout camp up in Iowa. My daughter Lauren is away at a YMCA camp down in southern Missouri, so the bad news hit pretty close to home. Looking forward to a big weekend here in St. Louis as the entire office is going to watch the Cardinals on Friday night. Hope everyone has a tremendous Thursday!!

Chris Gaffney, CFA
Vice President
EverBank World Markets

Posted 06-12-2008 9:29 AM by Chuck Butler