More of the same for the Euro and US$...
Daily Pfennig

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In This Issue..

* More of the same...

* Chuck's take on the Aussie $...

* Currency intervention...

* Brazil complains about the low rates in the US...

And Now... Today's Pfennig!

More of the same for the Euro and US$...

Good day... It was a very quiet day in the currency markets yesterday, as investors weighed concerns regarding the US economic recovery vs. worries over the debt problems at European banks. As I sat down to write this morning, the currencies are pretty much exactly where they were yesterday at this time, and with a limited amount of data releases in the US, I would expect more of the same today. The only data to hit the US markets today will be the S&P/CaseShiller home price indicators which will likely show continued weakness in the housing sector; and consumer confidence which is expected to have fallen slightly in September.

European markets continue to trade cautiously as Ireland's deteriorating public finances have reminded investors that the European sovereign debt crisis is far from over. The folks over at Standard & Poors rating agency threw fuel on the fire which is lapping at the peripheries of the Euro with talk of further down grades in sovereign debt ratings. S&P analyst David Beers who is Global Head of Sovereign Ratings said the following at an event in London last night: "We're now in an era which I and my team think is going to persist for quite some time to come - because of the coming demographic public finance pressures which are looming before us as well - where we do expect there will be continued falls in sovereign ratings."

The Emerald Isle is in the crosshairs of currency traders lately as they complete a massive bail out of Anglo Irish Bank. The stronger economies of Europe breathed a sigh of relief as Ireland and Spain have had recent success in refinancing their debt issues, but they continue to worry about the need for additional support of these weaker sisters. Ireland's deficit is forecast to be more than 20% of GDP, which is wider than the budget deficit of Greece. Worries over a possible bankruptcy of Ireland have driven credit-default swaps back up to levels we haven't seen since the Greek default crisis.

Credit Default Swaps are derivative contracts which insure holders against the possibility of a default. They are basically a life insurance policy on a country. While these swap contracts were originally designed to be used by holders of a country's debt to protect against a possible default, they have quickly turned into a leveraged play on the economic future of a country. These derivatives are now a good indication of investors concerns regarding sovereign debt issues. And European investors look like they are worried again! Credit default swaps tied to Irelands debt have more than doubled in the past two months and contracts on Portugal are nearing their record highs set in May. Costs of insuring against a default in Greece, Spain, and Italy are also rising.

So what does this mean for investors? Well Chuck has been warning everyone that the recent rise of the euro was a bit too fast, and that the sovereign debt crisis in Europe was far from over. Investors should continue to expect some volatility in the Euro area as the debt crisis ebbs and flows. But we continue to believe the EU will survive, and the euro will continue to hold its place as one of the world's most widely held currencies. While we may see a few pull backs, the euro will continue to slowly climb back toward $1.40.

Some good news in the UK pushed the pound a bit higher yesterday. GDP in the UK expanded 1.2% in the 2nd quarter, the fasted quarter of growth in nine years. But the party probably won't last, as the English face the prospect of the biggest spending cuts since WWII in order to tackle a record budget deficit. Much of this boost in GDP has come on the back of government spending, and these budget cuts could chop the recovery down at the knees. The IMF definitely believes the cuts will hurt the UK economy and cut its 2011 UK economic growth forecast yesterday. I am still not a fan of the pound sterling, as there seems to be much better investment opportunities elsewhere, and with less risk!

One of our long time favorite currencies for investment is the Aussie dollar, which was on the mind of Chuck as he settled down last night:

Well, after a day of meetings here in Jacksonville, I'm back in my room, reading, and doing a normal night's research for the next day's Pfennig.

I guess, what I really want to talk about today, is the fact that I talked about how I thought the Reserve Bank of Australia (RBA) would most likely wait until the 1st qtr of 2011 before hiking rates again. But that was before, the Budget talk by the Aussie Gov't, and their claim that they would bring the Budget Deficit back to a surplus next year. That's the kind of talk I love to hear from Central Banks, even though most Central Banks, in my opinion, are useless! In this case the RBA has always been, in my opinion, prudent. and providing price stability.

The talk in Australia has changed to: Well, maybe the RBA will hike rates again this year. and that talk has investors and traders are now turning up the heat, with more and more of them looking for another rate hike this year. and with all that talk. comes A$ strength. and so it is that the A$ is at a 2-year high.

I'm usually asked to give a short "Chuck's take on the economy" when I'm in Jacksonville. but not yesterday. Apparently the Big Boss, Frank Trotter, gave them that last week when he was there.. So, the folks in Jax didn't get my spin on things. too bad. Because, I'm not buying the Kool-aid that so many people are buying and the media is drinking! But by being Pfennig readers, you get it daily! So, thanks for staying with this letter!

Me again. Chuck has been a proponent of the Aussie dollar and the RBA for several years now, so I'm sure he is taking a bit of pleasure in seeing its stellar performance as of late.

The subject which has been dominating the news wires over the past few days is currency intervention. The US has been trying to pressure China into allowing greater appreciation of the Renminbi which has risen just 2% vs. the US$ this year (and all of that rise has come in the past 3 months). US lawmakers will vote at the end of this week on legislation that would allow US companies to petition for higher duties on imports from China in order to compensate for the effect of a weak currency. In response, China has announced it would slap a higher tariff on American poultry imports.

Sure looks like the beginning of a trade war which is not what the US needs right now! Especially when the engine of global growth is centered in China. The US is going to need the growing markets of China in order to sustain any hope of a recovery, and a trade war could quickly escalate; cutting off any hope of an export driven recovery. US lawmakers need to just stick to jawboning the Renminbi lower, and stay away from tariffs. China has begun to allow the slow appreciation of their currency, and slapping tariffs won't speed up the process. They will continue their slow and steady approach to currency appreciation.

Another country which has been in the news regarding currency intervention is Brazil, where the Finance Minister has said his government stands ready to buy all 'excess dollars' in the market to curb the real's appreciation. Brazilian Finance Minister Guido Mantega said yesterday that the world is in an 'international currency war' as governments try to gain a competitive advantage. Brazil joins Switzerland, Japan, and China who have all intervened in the currency markets over the past few months in order to keep their currencies from appreciating too rapidly.

Lower interest rates across most of the developed world have caused investors to seek out higher yields, forcing the currencies of emerging markets higher vs. the developed nations. These abnormally low rates are another form of currency manipulation according to the Brazilian Finance minister. "The advanced countries are seeking to devalue their currencies," Mantega said, mentioning the US, Europe, and Japan.

I think Mantega is right on the mark, but there isn't much he can do about it. The developed nations will continue to keep rates abnormally low, and the emerging markets don't have deep enough pockets to combat the huge amounts of currency flows seeking higher yields. I expect him to continue to try and jawbone the Brazilian real lower, but I don't see it having more than a minor impact on the real. Brazil continues to be a good place to place speculative funds.

To recap...The currency markets had a flat day yesterday, Europe turns its attention to the Irish debt crisis. Data from the UK show a strong quarter of growth, but what happens when the govt stops spending? Chuck gave us his opinion on the Aussie, and the US congress looks to be pushing us into a trade war with China.

Currencies today 9/28/10: American Style: A$ .9626, kiwi .7355, C$ .9690, euro 1.3468, sterling 1.5852, Swiss 1.0159, ... European Style: rand 7.0149, krone 5.9273, SEK 6.8534, forint 206.24, zloty 2.9517, koruna 18.2725, RUB 30.5699, yen 84.09, sing 1.3202, HKD 7.7583, INR 45.1850, China 6.6913, pesos 12.5559, BRL 1.7106, dollar index 79.42, Oil $75.82, 10-year 2.53%, Silver $21.19, and Gold... $1,289.13

That's it for today... It was a chilly fall morning here, and it took a while for the inside of my car to warm up. I had to park it outside last night as we have begun a major project in our back yard tearing down a deck which has been needing replaced for a couple of years. My wife loves the dumpster which is now parked on the driveway (not!!), so my goal is to try and get the deck down and the dumpster moved by the end of the week. Chuck is flying home later today, so he will be back in the saddle tomorrow morning. I hope everyone has a Terrific Tuesday!!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 09-28-2010 9:57 AM by Chuck Butler