2005 Revisited?

"The futures traders are beginning to go long the dollar again. We haven't seen this since 2005… But, here it is, staring us in the face. The question from me would be simply… What is driving them to go long the dollar?"

by Chuck Butler

In This Issue…

• Buying dollars…        
• Trade Deficit narrows…         
• Risk creeps back into stocks…         
• Recession explanation…

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And now…today's Pfennig!

2005 Revisited?

Good day… And a Marvelous Monday to you! I hope all you mothers and mothers-to-be enjoyed a wonderful Mother's Day! It was a very ugly weather day here in St. Louis, so the outside activities had to be moved inside… UGH!

I'm going to come front-and-center with something this morning that will probably scare a lot of euro holders. That's not my mission with this talk… But it's something I have to talk about.

The futures traders are beginning to go long the dollar again. We haven't seen this since 2005… But, here it is, staring us in the face. The question from me would be simply… What is driving them to go long the dollar?

Ever since the bailout of Bear Stearns, the markets have looked at the awful U.S. fundamentals in a new light, and clearly just don't care about what's ailing the U.S. economy any longer. They believe they have seen the bottom. (I wonder if they've seen the stock market sell off late last week?). So, here we are, circa January 2005… When the sentiment toward the dollar changed and the dollar gained back a chunk of ground until late that year.

This all comes back to the Bear Stearns bailout… And now what the markets believe is a sign by the Fed that rate cuts are over… The markets believe that since the Fed is no longer cutting rates, that they're sounding the "all clear horn". They also believe that the European Central Bank (ECB) will begin to cut rates in September of this year. So… The futures traders have pinned their colors to the dollar's mast.

You may recall about a month ago, I said how I agreed with my chartist friend who pointed out a dollar rally on his charts. He also said that the long-term trend would remain in place. So… There you have it.

Now some people seem to believe that this has all taken place with the G-7 meeting, in which you may recall they uttered some words about the dollar. I won't say that G-7 hasn't had anything to do with this dollar rally, but I wouldn't go as far as to say it is the end all of the rally.

So… If you're in currencies to diversify and hedge your portfolio, then this might be somewhat trying times. If you're simply in currencies to jump on the weak dollar bandwagon, then this is certainly a tough row to hoe for you.

But it is what it is… We have to deal with what I used to call "sex, lies and videotape" when discussing the lies and book-cooking that goes on in the United States. We have to deal with markets that change their views on a dime… And we have to deal with something that's trying to fundamentals believers like me. The fundamentals all point to a weak dollar… And yet… We see a dollar rally.

We can only hope that this change in view by the markets is something that burns out like the 2005 rally, which had props to help the dollar along. There are no props this time - at least none that I can see - so who knows how long this will go on… But, I felt that it was important to tell you what I'm seeing and hearing these days.

And before we get our pants all bunched up, we need to keep in mind what 40 strategists recently polled by Bloomberg had to say… And that is that the dollar will strengthen to 1.50 by year-end.

Folks… It's trading at 1.5480… That's not a huge move. Obviously, things could get out of hand… But if all we're talking about is to 1.50… That's just about what I kept telling you all might happen back at the beginning of the year, when the euro (EUR) was 1.45 and I said it could go to 1.40, before moving higher again. So, I'm off by 10 cents!

Did you all see the story in the NY Times Magazine in Sunday's edition? I appreciate the writer, Rob Walker, spending time talking to me and printing some of what I had to say.

OK… This week we'll see some data that will remind us of the awful fundamentals in the United States. The data includes April retail sales… And a quick check at the Butler Household Index (BHI) says that retail sales will print soft. On Thursday, we'll see the TIC's data (net foreign purchases), industrial production, capacity utilization, and the Philly Fed Survey (manufacturing). We end the week with housing starts, and consumer sentiment.

There's not one piece of data this week that will print as a strong fundamental for the dollar. The trade deficit on Friday came in at a much smaller number than forecast - "narrowing" from $62.3 billion to $58.2 billion in March. Now… Isn't that a "good thing"? How did we do this? Ahhh grasshopper, the U.S. consumer is spent… But beyond that, exports were off a bit - if only after posting 12 straight monthly gains. How did that happen? A WEAK DOLLAR!

And what will happen to this deficit if the dollar rallies? It will get worse again! But hey! Don't let that bit of information get in the way of a dollar rally!

We have two non-voting Fed Heads speaking today… Evans and Lockhart… Evans will speak about the economic outlook, which ought to be interesting. You never know what these Fed Heads will say, and what their hidden agenda is.

On Friday, I spoke to you about the HUGE loss AIG printed. Well, that news sent stocks down… And also put "risk" back into the stock market… And just that little bit of risk back in the stock market, helped Japanese yen (JPY) to its best trading day in weeks.

I've explained this relationship so many times I could do it in my sleep… But for the new readers, let me explain… Japanese yen is a low yielding currency (along with Swiss francs (CHF)), and in a "carry trade" the low yielding currencies get sold short (because the borrowing costs are so low), and the proceeds are used to buy higher yielding assets. For a while it was high yielding currencies, but most recently U.S. stocks were bought with carry trade funds.

The carry trade is considered a "risky trade"… So whenever "risk" creeps into the markets, the carry trade is unwound, which means one asset is sold, and the low yielding currency that was sold short, gets bought to cover the short, thus "unwinding" the trade.

I'm a believer, and I wouldn't leave her if I tried…. No Wait! No monkeying around here!  (Get it?) But I believe we'll see more "risk events" this year, and that Bear Stearns wasn't the only one. That would be good for Japanese yen and Swiss francs… And not so good for the markets.

So… Have you received your $600 check yet? Of course there are millions that won't get a check (I for one!), but there's some bad news for the government that thinks these checks will stimulate the economy. In a recent survey by Bloomberg, the tax rebates are not expected to prevent the U.S. economy from stagnating in the second quarter.

Many of you know that I went on record saying that we were in a recession two months ago… Here's some interesting tidbits regarding a recession that was sent to me by a trader friend at RBC.

"The 'R' word has been increasingly suggested as an appropriate characterization of the current situation. Some argue that without two consecutive quarters of negative GDP growth there simply cannot be a recession, while others castigate policymakers who demur from using the term as being dishonest. As is usual, the truth lies somewhere between these polar positions. As to the two consecutive quarters of negative GDP growth requirement, it simply does not exist. Perhaps the reason for this 'urban legend' is that recessions generally involve two negative quarters of growth, but note that while the 2001 recession lasted from Mar - Sep'01, there were not two consecutive quarters of decline (GDP fell 0.5% in Q1, rose 1.2% in Q2, and then fell 1.4% in Q3). While the National Bureau of Economic Research does consider GDP as a comprehensive measure of activity, it also looks at a variety of other indicators, with the major ones being real personal income less transfer payments, employment, industrial production, and volume of sale of the manufacturing and wholesale-retail sectors. As to policymakers being disingenuous, calling a recession is very simply not their call; the NBER is tasked with dating recessions and can do so only after establishing that a trough in diminished economic activity has been established. Even assuming the economy has entered a recession, data only exists to suggest a cyclical top, and so publicly declaring a recession would be premature."

OK… So maybe I was premature with my call… But I believe that the history books will show that I was bang on!

Currencies today 5/12/08: A$ .9445, kiwi .7690, C$ .9955, euro 1.5450, sterling 1.9580, Swiss .9530, ISK 79.62, rand 7.6666, krone 5.0720, SEK 6.0060, forint 162.35, zloty 2.1970, koruna 16.1575, yen 104, baht 32.50, sing 1.37, HKD 7.7955, INR 42, China 6.9880, pesos 10.5450, BRL 1.6850, dollar index 73.20, Oil $125.44, Silver $16.82, and Gold… $884.10

That's it for today… I'm writing from home this morning, as I did a real bonehead thing on Saturday. I was out driving around running errands and forgot to pick up my cleaning! So… This morning, when the cleaners open, I get it, pack it, and get on a plane to Las Vegas! What a brain drain!

I did an interview with NPR on Friday. I hesitated in taking the call, thinking that they could be baiting me… But no… It went fine. They wanted 15 minutes; they got 25 minutes of "Chuck-speak"… So, I'm leaving on a jet plane… I do know when I'll be back again! Not till Friday! I have a very early flight on Friday out of Vegas, which means I have to be at the airport to go through security, at least two hours before… So… I'm going to have to see if Chris can get the Pfennig out on Friday from Panama… Otherwise, I'll be up all night writing, while most people go to Vegas to be up all night partying! I hope you have a Marvelous Monday!

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Chuck is the author of The Daily Pfennig, which is reposted here at The Daily Reckoning. His respected analysis is frequently quoted in or referenced by: the Wall Street Journal, U.S. News and World Report, CBS Market Watch, USA Today, CNNfn, the Chicago Tribune and many other publications.

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