Risk aversion returns…
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In This Issue..

* Risk Aversion returns...            
* Money Multiplier dampens stimulus effects...         
* TIC flows show concern of foreign investors...                          
* China back on growth track...                                                               

And Now... Today's Pfennig!

Risk aversion returns...                

Good day... Chuck got an early start on a two week hiatus from the desk, so you will be stuck with me writing the Pfennig for the next two weeks.  But don't worry, you will still get a small dose of Chuck over the next week as he typically emails me his thoughts while on the road (I call it Pfennig Pfodder).  Risk aversion dominated the currency markets overnight, as terrorists set off two separate explosions in Jakarta and investors moved money back into the 'safe havens' of the US$ and Japanese yen. 

Chuck wrote about this move yesterday, believing the bad news regarding CIT would probably cause a risk reversal.  But the US stock market shook off the CIT news and rallied higher after a big earnings report by JP Morgan and a somewhat positive statement by Nouriel Roubini.  Roubini, the New York University economist who is credited with predicting the financial crisis, said in a speech yesterday that the US economy might be close to the bottom.  The stock jockeys took this statement along with the positive earnings reports and ran stocks up.  But Roubini later tried to caution these bulls against reading too much into his statement, and reminded everyone that he has not changed his thoughts on a US recovery: "I continue to see a shallow, below par and below trend recovery." 

Those looking for a quick v shaped recovery will be disappointed, as we continue to believe the recovery here in the US will be more of an L shape as our economy struggles to recover.  After all, who is going to propel the US economy to recovery?  In past recessions, we have been able to depend on the US consumer to pull us back out.  But the poor consumer is now facing the highest unemployment rate post WWII combined with falling home prices and much stricter lending policies.  And with the dire fiscal position of most states matching that of the federal government, the tax burden placed on almost all taxpayers will likely be rising, chewing up more of consumers disposable income.  We are no longer be able to rely on US consumers to 'borrow and spend' our way to GDP growth (which is actually a good thing!!).  Consumers are tightening their belts, and saving a larger percentage of their income; good news for the consumers, but bad news for the economy.

The administration has tried to take over where the US consumer left off by borrowing record amounts of money and injecting it into the economy through stimulus packages.  But recent data bring into question whether or not this stimulus is having the desired effect, and many are now questioning whether any fiscal measures can pull the economy out of recession.  With the credit markets still tight, and the negative outlook for consumer demand, no amount of government intervention seems able to stop the decline in jobs and quickly pull the US out of this recession/depression.  The reason is that the 'multiplier effect' of the stimulus money is too low.  Typically when the government injects funds into the economy, the effect of each dollar they spend is multiplied several times over as it moves through the lending / spending cycles. It works like this: $1,000,000 given to a bank by the Fed is lent out to consumers and business who then spend the funds on goods and services.  The companies who sell the goods and services place a majority of these funds back into the bank who then turn around and lend them back out, starting the cycle all over again.  But recently neither the banks or the consumers are acting 'normal'.  Banks who have received stimulus funds are using them to shore up balance sheets and keeping them in reserves.  Consumers who have received stimulus funds, or are strong enough to qualify for loans have been doing the same thing; using the funds to pay down debts and saving a larger percentage.  So the multiplier effect of each dollar injected by the administration has been much smaller than in years past.  While some in the administration are calling for another stimulus package, others are now realizing the impact of government stimulus will continue to be decreased by the low multiplier.  The government should probably just let the recession take its course, and avoid adding more debt to our already over burdened tax payers.

But 'big government' is back, and the current administration obviously feels it is their job to make government even bigger.  Chuck had this to say about this weeks earlier announcement of a new government run health care program:

"The Big Debate right now is a National Health Care program... I'll come right out front and center and say that I'm not for it, which shouldn't surprise anyone that's been reading this letter very long. But there's someone else who should be more important a figure against this than I think the media is reporting...

I'm talking about Douglas Elmendorf, the Director of the Congressional Budget Office who, under questioning by members of the Senate Budget Committee, had this to say...
"Instead of saving the federal government from fiscal catastrophe, the health reform measures being drafted by congressional Democrats would worsen an already bleak budget outlook, increasing deficit projections and driving the nation more deeply into debt."

He went on to say... That "bills crafted by House leaders and the Senate Health Committee do NOT propose the sort of fundamental changes that would be necessary to reduce the trajectory of federal health spending by a significant amount."

But... I doubt they listen to him... For when it comes to spending and driving up the deficits.. They haven't listened to former CBO director, Alice Rivlin... And they haven't listened to former Comptroller General, David Walker... Why the current CBO director now?"

Data released yesterday showed the number of Americans filing claims for unemployment benefits fell last week to the lowest level since January.  But like last week, these jobless claims were skewed by the Labor Department's 'adjustments'.  As I explained last week, the automakers typically lay off workers during July, so the BLS adds back thousands of jobs in order to offset these seasonal layoffs.  But this year, the auto plants laid off these workers months ago, so the seasonal adjustments are adjusting away actual job layoffs, not just temporary automobile layoffs.  These distortions will likely continue for the next few weeks, with the weekly numbers climbing back over 600,000 in August when the seasonal adjustments end. 

The TIC flows were also released yesterday and showed International demand for long term US financial assets weakened in May.  Investors sold the most Treasury notes and bonds in six months, with the net Long-term TIC flows dropping almost $20 billion.  The 'experts' had predicted a rise of $16.5 billion in purchases.  But as investors dumped long term Treasuries, purchases of US stocks in May were the strongest since January of 2008.  So the impact of these flows were minimal on the value of the US$.  The administration has to be worrying about the direction of the TIC flows, as it continues to bring record amounts of Treasuries to the markets.  If investors shy away from the new debt, interest rates will be driven higher putting further pressure on our 'stealth recovery'. 

After reviewing the numbers, I spotted another item which should be cause for concern.  The report showed foreign governments were moving from the longer term maturities of Treasury notes and bonds into shorter term bills which have a maturity of less than one year.  Foreign governments continue to be worried about the future ability of the US to maintain our record deficits.  The Chinese economy continues to grow, and is propelling them to a much more important status among global leaders.  Chinese Premier Wen Jiabo continues to express concerns regarding his country's US Treasury holdings, and officials in Japan, the second largest investor, have also begun to express concern.  The administration is calling in the big guns to try and assuage China's concerns.  Federal Reserve Chairman Ben S. Bernanke will brief  Chinese officials at a summit this month about how the US plans to keep inflation in check over the next few years.  The summit is the first high-level gathering of its kind since President Obama took office. 

China reported yesterday that their economy grew 7.9% in the 2nd QTR, which was greater than the 7.7% forecast by economists, and the 6.1% that was booked in the 1st QTR. This was the first acceleration in growth in more than two years, and comes on the heels of a $585 billion stimulus package which was targeted at increasing infrastructure and getting credit flowing again.  The positive growth number will likely cause them to start raising rates in 2010 according to a Bloomberg news survey.  Economists predict the one-year lending rate will climb over 50 basis points after remaining steady for the rest of the year.  China is the only one of the 10 biggest economies that is expanding, and confirms what we have been saying for some time: China will be the engine which propels the global economy out of recession. 

Chuck noticed the good numbers out of China before heading out yesterday, and sent me the following:

"This news must be manna from heaven for Australian commodity exporters... As I've said for some time now... China's economic strength = strong demand for raw materials, of which Australia is not only geographically positioned to supply China with raw materials, but has the raw materials to supply to China! And demand for Australian raw materials is a proxy for commodities as a whole... And, will underpin the A$!"

If you agree with what Chuck is saying regarding the A$, it may be a good time to buy some more as the AUD$ slid below .80 overnight due to risk aversion.  Both the AUD$ and NZD$ fell against the dollar and the yen as investors shifted to safe haven currencies.  The New Zealand dollar fell the most in two weeks after Fitch Ratings cut the nation's long term sovereign credit rating outlook to negative.  Fitch said the nation's deficit is large and a "stronger fiscal adjustment than currently planned" may be needed.  First, I think everyone should treat anything coming out of the rating agencies with caution.  But I agree that the nation's deficit is too large, but the news coming out of China should go a long way toward pushing these commodity exporting countries back into the black.  As Chuck says above, as China expands the commodity currencies should stay well bid.

Before I head to the big finish, Chuck wanted me to make this announcement to all the Pfennig readers....

After 2 long years of looking for the next MarketSafe CD to issue, I decided to put together the countries that have been in the news lately. So... Introducing: The EverBank MarketSafe BRICK CD! This will be a 3-year CD that will have FDIC protection, 100% Principal Protection, and 100% of the upside of the combined values of the currencies from Brazil, Russia, India and China! If the combined values of these 4 currencies should go down in 3 years, you'll get your principal back!

To invest in this new MarketSafe CD, you need to either go to: www.everbank.com where after reviewing the offering you will be able to apply for the CD right on line, or by calling the trading desk @ 1-800-926-4922 for the details.

Currencies today 7/17/09: A$ .8000, kiwi .6444, C$ .8945, euro 1.4100, sterling 1.6291, Swiss .9276, rand 8.102, krone 6.3926, SEK 7.8203, forint 194.08, zloty 3.0682, koruna 18.3992, yen 93.83, sing 1.4504, HKD 7.7501, INR 48.68, China 6.8316, pesos 13.58, BRL 1.9318, dollar index 79.49, Oil $61.93, 10-year 3.56%, Silver $13.19, and Gold... $934.45

That's it for today... The EverBank kickball team pulled out another victory last night in a tightly contested match.  Happily, none of our players were injured, but a player on the opposing team did a faceplant which still has everyone on the desk laughing.  The weather here in St. Louis has turned fall like, and we are supposed to have record lows over the weekend.  Should be perfect for a triathlon I am competing in Sunday morning.  Hope everyone has a Fantastic Friday and a Wonderful Weekend!!

Chris Gaffney, CFA
Vice President
EverBank World Markets

Posted 07-17-2009 12:11 PM by Chuck Butler