ECB WARNING ABOUT RAISING RATES BOOSTS EURO AND WEAKENS THE DOLLAR -- THAT COULD MAKE INFLATION EVEN WORSE BY PUSHING COMMODITY PRICES HIGHER -- EMERGING MARKETS CONTINUE TO SHOW IMPROVEMENT -- EUROPEAN SHARES TRADE HIGHER
TRICHET SAYS ECB MAY RAISE RATES... The ECB Bank President announced today that a more vigilant stance against inflation is now warranted, and warned that the European central bank may raise rates as early as next month. That pushed the Euro sharply higher and the U.S. Dollar lower. Chart 1 shows the Euro climbing to the highest level in four months. Chart 2 shows the Dollar Index trading lower and threatening its November low. The expectations for higher foreign rates, combined with the Fed's stated intention to keep U.S. short-term rates near zero, should weaken the dollar even further. A weaker dollar would push commodities even higher and make inflation worse.
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Chart 1
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Chart 2
FALLING DOLLAR IS CONTRIBUTING TO RISING COMMODITIES... In my Tuesday message, I agreed with the Fed chairman that commodity prices were rising against all currencies. That doesn't mean, however, that the falling U.S. Dollar isn't a major contributor to rising commodities. After all, global commodities are priced in dollars. Chart 3 shows that the latest surge in the CRB Commodity Index began last June just as the U.S. Dollar Index was peaking (see arrows). A dollar bounce during the fourth quarter coinicided with a modest commodity pullback. The dollar downturn during the first quarter of this year has contributed to another commodity surge. One of the most consistent intermarket relationships is that the dollar and commodities trend in opposite directions. The charts below all show a clear inverse relationship between the two markets and appear to contradict the view expressed by Mr. Bernanke that the lower dollar isn't a major reason that commodity prices are rising. Chart 4 shows them moving in opposite directions since 2007. Note their coincident turning points in 2008, 2009, and 2010. Every major turn in the dollar coincided a major turn in commodities in the opposite direction. Chart 5 gives an even longer view, and shows that the major upturn in commodities that started in 2002 coincided exactly with a major downturn in the dollar. A lot of the dollar weakness since 2002 is directly tied to aggressive Fed easing and, more recently, to the Fed keeping U.S. rates near zero. With rates in emerging markets already rising and Europe close to raising rates, it seems the dollar has nowhere to go but down (at least until the Fed starts raising rates). That should push commodity prices even higher and make the inflation problem even worse. That will be especially true in the U.S. which now has the world's weakest currency.
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Chart 3
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Chart 4
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Chart 5
RISING COMMODITIES PUSH CANADIAN DOLLAR AND POUND HIGHER... Another corollary to the dollar/commodities inverse relationship is that commodity prices and foreign currencies rise together (since both move opposite the dollar). I've explained in previous messages that commodity producing currencies like the Canadian Dollar are closely linked to commodity prices. Chart 6 shows how close. Notice that the rising Canadian Dollar (red line) and CRB Index (brown line) over the last year are almost identical. That makes the Canadian Dollar another excellent hedge against rising inflation (as are commodities). Chart 7 shows a link between a rising British Pound (blue line) and crude oil (black line). The Pound has just recently touched a new 52-week high along with crude. There's talk that the Brits may be getting ready to raise rates as well to combat rising energy prices. That's probably why their currency is acting so strong. Rising rates boost a currency's value, especially against another currency (like the dollar) whose central bank keeps rates near zero.
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Chart 6
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Chart 7
EMERGING MARKETS STRENGTHEN ... I recently showed Emerging Market iShares (EEM) starting to recover from chart support along their late-November lows. That recovery is looking even better. Chart 8 shows the EEM trading back over its 50-day average for the first time in a month. Brazil iShares in Chart 9 are doing the same after bouncing off their 200-day average. Two Thursdays ago (February 17) I wrote that China iShares (FXI) were rebounding from an oversold condition and had regained their 200-day average. Chart 10 shows the FXI closing back above its 50-day line for the first time since mid-January. It's also breaking a down trendline from last November's peak. [India (not shown) is also rebounding but has yet to reach its 200-day line. India, however, has a relatively small EEM weighting. The Russian market (also not shown) is hitting new highs on the back of rising energy prices]. The improvement in emerging markets has, in my opinion, removed a near term threat to the global stock market recovery.
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Chart 8
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Chart 9
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Chart 10
EUROPE HOLDS UP OK AS US STOCKS BOUNCE... European stocks took the news of an impending central bank tightening in stride and are trading higher on the news. Chart 11 shows the Europe 350 iShares (IEV) nearing a new recovery high. U.S. stocks are rebounding as well. Chart 12 shows Power Shares QQQ Trust gaining 2% today and bouncing sharply off its 50-day average (blue line). The ability of U.S. stock indexes to stay above their 50-day averages has kept their uptrend intact. A pullback in crude prices and a strong employment report are contributing to the day's stock gains. Gold is pulling back a bit along with oil. I expect that pullback to be temporary. A weaker dollar should keep the major commodity uptrend intact. A weaker dollar should also give a boost to foreign shares which benefit from stronger local currencies. Large-cap multinational U.S. stocks should also benefit from a weaker dollar because of increased foreign sales.
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Chart 11
