Irish debt crisis continues to push the euro lower...
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In This Issue.

* Irish debt crisis pushes the euro lower

* Inflation worries drive US rates higher

* Fed's focus may be narrowed by congress

* Gold demand rises in India

And, Now, Today's Pfennig For Your Thoughts!

Irish debt crisis continues to push the euro lower...

Good day... Chuck received some bad news last night, his younger brother passed away from a heart attack yesterday. So he asked me to fill in and write the Pfennig for him this morning. This will probably be a bit shorter than usual, but hopefully I will be able to cover all of the currency moves which occurred in the last 24 hours.

The dollar continued to move higher vs. the major currencies yesterday as the European debt crisis continued to weigh on the currency markets. Sentiment in the currency markets has shifted recently from a negative dollar position back to a short term dollar positive. Bond yields here in the US have ticked up lately (more on this in a bit), due to inflationary concerns; and the problems in Europe have taken center stage now that the Fed's QEII announcement is behind us. Short term traders now believe the dollar rally will last for another month. UBS, the world's second largest foreign-exchange trader sees the US$ advancing to $1.30 per euro in one month, compared with its previous forecast of $1.40.

This is why neither Chuck nor I like to try and predict where the short term markets are headed, things can change rapidly over short time periods, and you have to constantly re-evaluate your predictions. It is much better to take a longer term view of the markets; diversify into those currencies you believe will hold their value, and don't sweat the short term volatility. But for all of you investors who were kicking yourself for not placing more of your money outside the dollar, this one month dollar rally may provide you the perfect buying opportunity.

European debt worries are increasing as the European finance ministers met in Brussels to discuss a possible rescue package. Ireland's leaders have not asked for additional help, and the finance ministers praised Irelands budget cuts, sounding a lot of the same themes as they used during the early stages of the Greek crisis. IMF officials are headed to Dublin tomorrow to begin talks on the banking system's needs. It seems as if Ireland will probably make it through, but bond traders continue to put pressure on them. As we have pointed out in the past, some large investors see the European markets as being 'ripe for the picking' and have used leverage and short positions in the bond markets to reap profits. This is the major problem facing the EU, as these bond investors move from one country to another, pouncing on the weakest and forcing the hand of the EU. So once the furor over Ireland quiets, I'm sure we will see them go after Portugal, and then Spain or Italy.

This is why we don't suggest investors move into the Euro anytime soon. These debt problems will persist, and hold a lid on any appreciation of the Euro vs. the US$, in spite of what happens here in the US.

Switzerland maintained their economic independence, choosing not to be a part of the Euro. But while the franc remains independent from the euro, the Swiss economy is still very dependent on a healthy Europe. The Swiss franc has weakened for eight consecutive days as investors move funds back into the US. Switzerland's producer and import prices fell by .4% in October following a decline of .1% the month before. This data supports the thought that the SNB will hold rates steady, and with the recent jump in US rates the Swiss franc has been falling vs. the US$.

As I just mentioned, another factor helping to rally the US$ is the prospect of higher rates due to possible inflation. Fear of the inflationary impact of an additional $600 billion of QE has driven bond yields higher recently. Bond holders got a bit of relief yesterday, as the Producer Price Index in the US showed inflation is running slightly lower than expected (for now anyway!). PPI moved 4.3% higher YOY while the core number (ex food and energy) moved up 1.5% v.s an expected 2.1%. So inflation hasn't filtered into the official numbers yet, but we all know the actual inflation numbers are substantially higher! And Republican lawmakers announced yesterday that they want to compel the Fed to focus solely on controlling inflation, instead of maintaining both stable prices and full employment. The Federal Reserve Act was amended in 1977 creating the dual policy roles for the Fed. But these two mandates are sometimes conflicting, and can confuse the markets. With the announcement of QEII, Ben Bernanke has ignored any future threat of inflation in favor of trying to get our economy back to full employment.

According to a Bloomberg news story last night, US Representative Mike Pence, chairman of the House Republican Conference, said he plans to introduce a bill today requiring the Fed to promote price stability while no longer seeking maximum employment. Senator Bob Corker, a member of the Senate Banking Committee also backed a single mandate for the Fed. A single mandate would help clarify Fed policy, and would probably reduce some of the volatility which we have seen recently in the markets. With the Fed's current (and sometimes conflicting) dual roles, investors have to try and guess which of the two mandates the Fed will be focused on with monetary policy. Switching to a single 'price stability' mandate would narrow the possibilities and reduce volatility in the bond markets.

Even the FOMC members sound confused as to what they should be doing. Chuck spotted the following on the news wires this morning:

Fed Heads with differing opinions about the $600 Billion QE2. the WSJ reports that Fed Head, Evans says $600 Billion was a "good place to start"... while Fed Head Rosengren said the Fed would need to consider more action if the economy weakens...

Our own St. Louis Fed head James Bullard sounded a bit less hawkish than normal, stating "the economy would have to improve a fair amount before the whole committee would pull back on the amount of quantitative easing. I think that is a possibility, but it would depend on hard data that would force us to reassess where the economy is going in the future."

Seems to me that this QE2 is all being driven home by Big Ben Bernanke.

Chuck also sent me a note which a reader sent him regarding the bond yields.

"The thought that is going around is that with the Republicans taking over, and now Ron Paul is going to be watching the Fed like a hawk. Big Ben Bernanke is not going to be allowed to carry on with his $600 Billion Quantitative Easing (QE). And since Gold's big run up in price was in reaction to the, first pending QE, and then the actual announcement of it, the "bets" if you will, are being taken off that $600 Billion of new dollars will be printed, and the need for a stronger Gold price. right now. is no longer needed.

Of course these same people selling right now, will be chasing the shiny metal when it turns around! I guess, to be legal with the "eye in the sky", I should say. "if" it turns around, and not "when".

Now. back to the bond sell off. there are lots of theories going around about the whys. and the inability of the FOMC to pull off QE going forward is at the top of the heap. But another one that's getting lots of air time, is the rumor going around that Moodys actually discussed a possible downgrade for the U.S. . If that were to happen, the bond bubble would make the loudest pop of all, louder than the tech Bubble, louder than the Housing Bubble, Louder than . well, it would be LOUD! So. apparently the Big Boys are getting out of Treasuries while the gettin's good! Of course as astute, Pfennig readers, you already knew this would eventually happen because you read about it in the Pfennig back when no one was talking about the Bond Bubble.

The Big Boss, Frank Trotter, sent me a note yesterday, showing me that a 30 year mortgage (4.25%) is cheaper than a 30 year Treasury (4.33%) . I'm sure there's a line in there, but if you just look at this factually, a home owner, as beaten and bruised as they have become is a better credit than the U.S. Treasury right now! Simply amazing!"

Back to Chris now. Other data released yesterday showed Industrial Production was flat in October, and the important Capacity Utilization number was also unchanged. This throws a bit of cold water on the idea that abandoning our 'strong dollar' policy would generate big gains in exports and stimulate our manufacturing sector. The weaker dollar didn't seem to have much of an impact on exports last month, as our manufacturing numbers were flat. Maybe the problem is that we no longer produce anything which the world wants to buy (?)

Other data released yesterday showed global demand for US assets declined in September from a month earlier. Net buying of long-term equities, notes and bonds totaled just $81 billion in September compared to a net $128.7 billion in August. The higher yields available in the emerging markets, and worries about the Fed's QEII announcement probably contributed to the fall. This doesn't look like a permanent shift out of US investments (yet), and the numbers will probably rebound as the dollar dropped and yields moved up slightly in the US over the past 30 days. Higher bond yields and a cheaper currency will probably attract foreign investors to our debt and equities.

Gold continued to sell off along with the majority of commodities yesterday. Gold is now down nearly 5% over the past 5 days, and high flying silver is down an even greater 6.32%. Commodity prices have been hit by steps China is taking in order to combat rising inflation. As we have seen in the past, commodity prices are highly correlated to expected growth in China. It is simply a question of supply and demand, and supply of the commodities is largely constant. So the demand side of the equation typically is what drives the prices. China's steps to slow down their economy, and worries regarding the future growth of Europe, has caused a drop in commodity prices.

But another story which I came across this morning supports the idea that demand for gold will likely increase. Gold imports by India, the largest consumer, have already exceeded 2009 levels as consumers boost purchases, according to the World Gold Council. This something which I have been suggesting to callers into the EverBank trading desk for the past few years. As everyone is aware, growth in both China and India has been phenomenal. This growth increases demand for commodities in order to support this growth. But the growth has also raised the standard of living for the citizens of these emerging markets. These citizens have shown a preference to hold wealth in the form of precious metals. So any additional increase in their standard of living has a direct increase in the demand for precious metals. Jewelry demand in India surged 36% in the third quarter, even as the price of gold shot up. According to the Gold Council, consumers in these nations have now adjusted their price expectations and are now anticipating higher prices. As China and India continue to grow, I expect their citizens to continue to increase demand for precious metals. Again, these levels should be seen as a buying opportunity.

To recap. Dollar rally continues as worries over Irish debt push the euro lower.

Currencies today 11/17/10: American Style: A$ .9758, kiwi .7668, C$ .9783, euro 1.3479, sterling 1.589, Swiss $1.0038, . European Style: rand 7.0662, krone 6.0697, SEK 6.9667, forint 206.32, zloty 2.9398, koruna 18.25, RUB 31.39, yen 83.48, sing 1.3043, HKD 7.7568, INR 45.315, China 6.6432, pesos 12.425, BRL 1.7373, dollar index 79.23, Oil $81.61, 10-year 2.86%, Silver $25.285, and Gold. $1,336.30

That's it for today. My sympathies go out to all of Chuck's family, who I know are regular readers of the Pfennig. Chuck told me his brother was just 45, certainly too young to die. It is a bit odd how Chuck's sister sent him a picture of all the brothers and sisters yesterday. While Chuck didn't feel up to writing this morning, he did come in early to do the trading, as we have been very busy on the desk, and he didn't want to put all of the trading responsibilities on Kristin. Hopefully everyone will have a Wonderful Wednesday...

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 11-17-2010 9:43 AM by Chuck Butler
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