Another Bad Day For The Dollar

"The dollar continued to fall yesterday and overnight with the euro and the yen both headed for the biggest weekly gain of this year. The dollar fell 2.3% against the yen and 2.2% versus the euro."

In this issue…

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And now…today's Pfennig!

Another Bad Day For The Dollar

Top O' the morning to ye! The dollar continued to fall yesterday and overnight with the euro and the yen both headed for the biggest weekly gain of this year. The dollar fell 2.3% against the yen and 2.2% versus the euro so far this week, after reports continue to show a slowing U.S. economy.

Driving home last night, I heard that our congress had taken steps to deal with the deficits, which are piling up.

They voted to raise the debt ceiling! Unfortunately, we continue to shift the burden of our current spending to our children and grandchildren. Of course, you won't see any of the members of congress jumping in front of the cameras to announce this move to the public. In fact, I didn't even see any mention of it in this mornings news recap. Americans just don't want to admit that we continue to live above our means. I guarantee these debts, which continue to pile up, will eventually drive down the value of the U.S. dollar.

February's consumer price report, released yesterday morning, showed inflation is slowing with the Ex Food and Energy number coming in at 0.1% below expectations. This, combined with weaker-than-expected retail sales and a record current account deficit, has caused traders to pare bets on how far borrowing costs are likely to rise from 4.5%. Much of the recent dollar strength was due to thoughts that the Fed would not only raise interest rates two more times to 5%, but they would continue all the way to 5.5%.

Readers know that Chuck believes all of this stupid interest-rate talk (SORT) is, well, stupid. It is our believe that in spite of all the SIRT noise in the markets, currency markets always move back to underlying fundamentals. Unfortunately for the dollar, the fundamentals just don't look good. A reader passed along an article, which appears in this week's Economist, titled "The Yes Also Rises," which details some of these fundamental problems.

"America's profligacy is now taken so much for granted that an enormous increase in its current-account deficit no longer makes front-page news. In the fourth quarter the deficit jumped to a record $225 billion, or 7% of GDP, lifting the deficit for 2005 as a whole to $805 billion. It has become fashionable in America to argue that the deficit does not matter--in particular, that it will not drive the dollar down. But fashions can quickly change.

"The deficit is likely to hit an annual rate of $1 trillion before the end of this year. Economists at ABN AMRO believe that on today's trends and at today's exchange rates it could hit 12% of GDP by the end of the decade. The problem is that America's imports exceed its exports by so much that exports need to grow almost twice as fast as imports just to keep the trade deficit in goods constant. But rising import penetration means that a given increase in domestic demand pulls in a lot more imports than it used to. Stephen Roach, of Morgan Stanley, calculates that imports now account for 37% of America's domestic purchases of goods, up from 20% in 1985. So as long as America's economy continues to boom, the trade deficit will widen."

The article goes on to say, "Economic theory says that the current-account deficit can be no help to the dollar; and after rising for most of 2005, the greenback has slipped by around 3% against the yen and the euro since November. Last year the dollar was supported by rising American interest rates, but the European Central Bank and the Bank of Japan (BoJ) have now also both started to tighten policy. The financing of America's deficit last year was also helped by the Homeland Investment Act, which allowed American firms a lower tax rate on profits repatriated from abroad. As profits come home, net foreign direct investment by American firms slumped to $21 billion, from $252 billion in 2004."

Sounds like the author just took this month's Review and Focus and rewrote it. Good to have a prominent magazine like the Economist validate what Chuck has been saying. I encourage you to go to Economist.com to read the entire article.

Lehman Brothers jumped on the bandwagon and cut its forecasts for the dollar against the euro. They state the boost the U.S. currency got from higher interest rates is fading after the ECB and BOJ have indicated a change in their interest rate policies. "The next clear trend for the U.S. dollar is likely to be to the downside," wrote strategists led by London-based head of global currency research James McCormick. Again, it is nice to have some of the "big boys" agreeing with what we have been saying.

The Swiss franc rose against the dollar after the country's central bank raised its interest rate a quarter point to the highest since July 2002. Another interest-rate hike in June is pretty much a done deal as the economic data continue to show the economy is moving at full speed. Swiss Economics Minister Joseph Deiss said, "The economic trend is pointing upward again," and further interest rate increases may be needed to keep inflation down.

This increase in Swiss rates will put more pressure on the "carry trades," which have been reversing as of late. Many investors have borrowed Swiss francs and Japanese yen in order to invest in the higher rate currencies of New Zealand and Latin America. As these borrowing costs increase, we are seeing some of these trades unwind putting downward pressure on these high-rate currencies. This is one of the main reasons we have been cautioning investors against the New Zealand dollar. Look for the NZD to continue to come under pressure as these trades are reversed.

Projected increases in the interest rates of Japan will undoubtedly increase the value of the Japanese yen, according to a story out of Australia overnight. The yen will strengthen when the yield of the 10-year Japanese government bond rises to two percent, because this will trigger the country's pension fund managers to bring cash home, said Commonwealth Bank of Australia. "In the past, this has been a real kicker for the yen. Pension funds increased their offshore investments in the search for yield and the yen depreciated," according a senior currency strategist. Japanese pension funds have guaranteed their members an annual two percent return, so a rise in bond yields will spur repatriation of funds invested overseas since the 10-year yield fell below two percent in late 1997, according to Grace. The yield of the 10-year benchmark bond touched 1.735%, the highest in 19 months. We continue to look for the yen to move back toward 105 by year's end.

I was a little late this morning, so I will get right to the big finish:

Currencies today: A$ .7326, kiwi .6360, C$ .8649, euro 1.2171, sterling 1.7533, Swiss .7742, ISK 69.18, rand 6.1928, krone 6.5476, forint 212.68, zloty 3.1526, koruna 23.43, yen 116.23, baht 38.99, sing 1.6173, China 8.0316, pesos 10.6325, dollar index 89.04, silver $10.39, and gold $555.62

That's it for today. I'll close this morning with a Happy St. Patrick's Day wish to my favorite Irishman, Dad. My grandfather left his home in County Roscommon at the young age of 11 and rode his bike across Ireland to Dublin where he went to work at the Guinness factory in order to earn enough money to come to America. After a few years, he sailed away from England on a sister ship to the Titanic, bound for New York. As the luck of the Irish would have it, a young girl who would eventually become my grandmother was also on her way to America. Both ended up coming to St. Louis where they settled down and raised six boys and a girl. So, each St. Patrick's day, I raise a glass of Guinness, who financed my Grandpa's trip to this great land of opportunity. Happy St. Patrick's Day to all of you!

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