Where There's Smoke…

"U.S. mall vacancies rose to a 13-year high in June. This is a real illustration of a slowdown in consumer spending. Consumers are spending, they just aren't spending it anywhere else but the gas station and grocery store!"

by Chuck Butler

In This Issue…

• Fed Head Yellen comes clean!
• $75 Billion in Capital needed?
• Another risk even?
• Higher inflation for Brazil…

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And now…today's Pfennig!

Where There's Smoke…

Good day… And a Terrific Tuesday to you! I'm writing from home today, as I have to deal with a catalytic converter this morning before heading into work. Writing from home is always a challenge in that I don't have my trading screens going with news scrolling continuously. But… I carry on despite my challenges!

The euro (EUR) recovered a bit yesterday after last Thursday's tailspin… And the recovery was smack dab in the face of some weak economic news from Germany! Here's what got the euro moving up once again yesterday.

San Francisco Fed Head Janet Yellen was speaking yesterday, and decided to "come clean" with her assessment of the U.S. economy. Yellen told her audience that she believed the economic slowdown would last for some time and that the jobless rate would continue to rise. The markets got a slap in the face with that talk, as they had all but forgotten the flaws in the economic fundamentals in the United States. They were all wound up with the fact that European Central Bank (ECB) President, Trichet, didn't sound hawkish last week! Dolts, I tell you… Major league dolts!

Trichet's words may have, at the time, moved the markets, but in the long run, it won't be enough to overcome the bad U.S. fundamentals.

U.S. mall vacancies rose to a 13-year high in June. This is a real illustration of a slowdown in consumer spending. Consumers are spending, they just aren't spending it anywhere else but the gas station and grocery store!

There's some smoke coming from Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE), and you know me… Where there's smoke, there's fire… Here's the skinny.

Fannie Mae plunged 16% to $15.74, the lowest price since July 1992. This company and Freddie Mac, the biggest sources of financing for U.S. mortgages, slumped as concern grew that they may need to raise more capital to overcome write-downs and satisfy new accounting rules. Freddie Mac declined 18% to $11.91, the lowest since November 1993.

Fannie and Freddie were rumored to announce bailouts yesterday afternoon. That didn't happen, but the markets smell blood in the water. The markets now feel as though these two will need approximately $75 billion in new capital to remain viable companies.

Could these two be the next "risk events" that I keep talking about in the United States? It's all rumors and hearsay now… But like the song goes… There's no smoke without a fire… There's no heat without a flame.

Or… Could it be the news from Indy Mac, who agreed with regulators to halt new loans under an agreement with the regulators, and then announced that they would cut half their staff as mortgage losses mount? Again, folks, I'm not picking on these companies because I have some vendetta against them. I'm just reporting what's on the news wires, as something that could affect the value of the dollar in the long run.

The euro mini-recovery failed to drag the other currencies along for the ride yesterday. This doesn't happen very often, but did happen yesterday. Maybe it will be a delayed action by the "little dogs".

Irwin Keller writes articles for MarketWatch, and I usually like what he has to say… And yesterday was no exception. Yesterday, Irwin Keller wrote about how the dollar is wagging the economy's tail. Let's take a minute and see what Irwin has to say…

"When the dollar goes down in world financial markets, the price of oil goes up. And, as we saw in early trading on Monday, when the buck bounces higher, oil takes a tumble. So where does the Fed come in, you might ask? After all, it can't produce one barrel of oil, no matter how low it pushes interest rates, so one must conclude that Fed actions can influence neither the supply of oil nor the demand for it. And if this is true, then the Fed has nothing to do with oil's price, right? Wrong, the actions of the central bank can go a long way toward determining the price of petroleum because these days, the value of the dollar against other currencies has a lot to do with the price of oil.

"If our central bank were to remove some dollars from the global financial system, the buck would rise in value against the other currencies."

Yes… That's called money supply. When you print tons of dollars and flood the market with them, the value of the dollars you printed goes down. It's been that way since the days of bartering… And, long time readers know that I have a strong distaste for the money supply the Fed's been pumping out for some time now. There are those that believe the Fed is slowing money supply… Well, if that's true, they aren't slowing it enough!

U.S. stocks continue to get taken to the woodshed, and I don't see any bright lights coming from this sector, as the earnings season is upon us. I think there will be quite a few companies that would like to skip over this earnings season, as it will not be a pretty sight… But, I'm not a stock jockey, and I'm not even your last choice as a stock jockey, so, I'll stick to currencies. The reason I mention stocks is that they tie together with the performance of the Japanese yen (JPY) and Swiss franc (CHF)…

For new readers… You see, these two currencies are tied up in the carry trade, where they are sold short, and the proceeds are used to buy higher yielding assets. This is considered a "risky trade" and as long as stocks are going well, there's no "risk" in the markets. But when stocks head south, risk aversion steps up, and the carry trades are unwound, thus making the investors that sold these two currencies short, have to buy them back to cover their short position. The "buying back" of the currencies pushes their values versus the dollar higher.

The Brazilian real (BRL) got a bit of a boost yesterday, when economists there revised upward their inflation forecasts. I know, I know, that all sounds weird, but that's the market mentality these days… Reward a country for high inflation as that will bring about higher interest rates. Never mind the fact that inflation is higher! So… Anyway, the real got a boost, and that's all I should care about, eh?

Chris Gaffney sent me a note yesterday, letting me know that I missed a Bank of England (BOE) interest rate meeting scheduled for this Thursday, when I was talking about the happenings around the world yesterday. So, my bad… I even have a calendar of Central Bank meetings that my friend and former colleague, Ashish sent to me…. UGH! Oh well, yes, the BOE will meet this week, but don't expect anything to come of it. The BOE has painted themselves into a corner just like their brothers-in-arms over at the Fed Reserve.

China announced plans this weekend to slow down the "hot money" that keeps flowing into the country. They see this "hot money" as bad, as well they should… Because this money isn't coming into the country as anything other than a short-term investment to ride what they feel is a one-way ticket to a higher renminbi (CNY) value. China, as I've explained many times in the past, would love to throw a spanner in the works of this perceived "one-way ticket", but just doesn't have the heart to do it for more than one day.

The new plans won't do anything either, at least not anything one could see from the renminbi's performance the past couple of days! Eventually, the Chinese will pull a rabbit from their collective hats and come up with something to slow down the "hot money"… But a currency that's really only moved "one-way" versus the dollar since July of 2005 when the peg was broken, is going to be a road block for sure!

Currencies today 7/8/08: A$ .9530, kiwi .7515, C$ .98, euro 1.5720, sterling 1.9740, Swiss .9745, ISK 76.94, rand 7.7880, krone 5.1050, SEK 5.9975, forint 147.75, zloty 2.1025, koruna 15.05, yen 106.75, baht 33.67, sing 1.3635, HKD 7.80, INR 43.29, China 6.8545, pesos 10.33, BRL 1.5995, dollar index 72.72, Oil $140.25, Silver $17.77, and Gold… $924.00

That's it for today… Just as I'm ready to sign off, I see the that euro has slipped to below 1.57. I don't see anything causing this, but I don't like the looks of this weakness right now. It could be nothing, we'll have to wait-n-see. I had two interviews yesterday - one with the Jacksonville Business Journal, and the other with the MarketWatch people. I have a special feeling for the MarketWatch stuff I do, as this was the first media outlet that would call me for my opinions. Back in the day, I was quoted on MarketWatch almost daily. Back then it was CBS MarketWatch, which was started by Tom Calandra. I believe the young lady's name was Rachel that used to call me all the time… Anyway, I'm not just a one trick pony anymore! OK… Time to hit the send button, and head off to take care of that catalytic converter… If I didn't like driving this car so much it would be history! So, take care, and have a Terrific Tuesday! Bye…

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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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