"Money is better than poverty, if only for financial reasons."

- Woody Allen

Issue #186: Friday, May 2, 2008

Bernanke's Beloved
Inflation Gauge -
"Even Better than the CPI"

Today's commentary is by Sean Hyman, Currency Analyst for The Sovereign Society.

Good day Currency Traders!

I was watching a speech Ben Bernanke gave before Congress some time ago. He mentioned that he closely watched the Personal Consumption Expenditures (PCE) Deflator. He stated that he considered it to be a "better CPI."

So why do I feel so strongly that I know the rate cuts are over and done with? Let's take a look at the charted prices of Bernanke's beloved PCE Deflator below. Check it out:

Bernanke's Beloved Inflation Meter

The Fed Can't Afford to Cut Rates Anymore if We're Still Following Bernanke's Beloved Gauge

According to this alternative gauge, inflation declined in 2006 and was mostly stable early last year, before spiking sharply higher in the second half of 2007 (at least according to Bernanke's beloved inflation gauge).

However, the recent spike higher has the PCE inflation gauge approaching its 2005 peak again - it's about to hit the point of no return. When it does, Bernanke will have no choice but to start fighting inflation again. And that means holding rates steady for the time being.

I don't know of one Fed member that's going to let this gauge climb above 4.0.

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What's Coming in the Next Weeks and Months

So what does all of this mean? If the Fed's taking a breather, then I'm bullish for the dollar in the near term. When I say "near-term," I mean the next couple of weeks and months. Also, the stock market has fought its way back recently, so carry traders will return to the market right along with other stock traders.

As a result, watch for "select" carry trades like AUD/CAD and AUD/JPY head higher overall. With the Fed's low 2.0% interest rate and oil, gold and other commodities coming off their highs, stocks as a whole will prosper at these levels. So carry traders will dive back into the market once again adding more fuel to this rally.

Australia's inflation will continue to remain high and Canada won't be raising rates any time soon, in fact, they could cut more. The Bank of Japan just announced its holding interest rates steady at the paltry 0.50%. So it looks to me like these carry trades have a "green light" for some time to come.

However, if another Bear Stearns incident shocks the markets, then all these carry traders will once again dive back into safer assets. And this will mean we're back to unwinding again.

Sean Hyman, Currency Analyst

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Making 'Cents' of the Headlines

What's Happening:

As you may remember, just last week two Goldman Sachs analysts issued a research note that declared "Asian currencies are undervalued versus the euro by about 25%."

Goldman - otherwise known as the one of the only Wall Street big-name firms to avoid the sub-prime debacle - advised all investors should be on the lookout for exactly when to enter the Asian currency market.

Well now Morgan Stanley is throwing in their two cents on Asian currencies - and they're saying the exact opposite:

"Investors should sell Asian currencies against the U.S. dollar on prospects the region's central banks will let their currencies weaken to revive faltering growth."

What We Say:

Weaken? Doubtful. In fact, our experts - including Jack Crooks - are saying that Asian countries will eventually let their currencies float freely against the world's other nations.

Don't be fooled by the muddy messages Wall Street's big names are sending. Asian currencies will continue to thrive for years to come- based on long-term solid fundamentals and greater growth prospects in China and her neighbors.

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