An agreement is likely sometime today.
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In This Issue.

* An agreement is near...

* Frank's view from above the fray...

* Eurobonds a possible solution for Europe???

* Risk is moving back into the markets...

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

An agreement is likely sometime today.

Good day. I was over at my mom's house yesterday watching the Cardinals lose to the Cubs (we can't even complete a sweep of the lowly Cubs!!) and the conversation invariably turned to the US debt debate. We had both watched the Sunday morning news programs and the rhetoric indicated that it was very possible no solution would be reached. But mom told me that a deadline is a wonderful thing, and reminded me of all the late nights I spent during high school working on papers at the last minute. High School and College would have been a lot easier if I would have figured out how to spread the work out a bit, but I always waited until the last minute. And while I always seemed to manage to get the papers turned in on time, I always wished I had just a few more hours to polish it up.

The pressure of a deadline is apparently what was needed to get Congress and the administration to finally agree on a debt reduction deal. The debt debate is probably nearing an end (for now) as leaders of both parties announced late Sunday that an agreement had been reached. The deal calls for at least $2.4 trillion in spending cuts over 10 years and a two-step increase in the debt ceiling. It also sets up a new Congressional committee to recommend a deficit-reduction proposal by Thanksgiving.

Wait a minute, didn't we already have a bipartisan committee which recommended ways to trim the budget deficit? As I recall, their suggestions were simply ignored by both congress and the administration. But this new Congressional committee will have a bit more muscle to back them up. It the committee fails to agree on a plan, or if Congress doesn't act on it, Congress would either have to approve a balanced budget agreement to the Constitution or accept an across the board cut in spending in line with the committee's goal, with 50 percent of the savings coming from the Pentagon beginning in 2013.

The increases of the debt ceiling would occur in two stages, with a $900 billion increase immediately, and a second increase of between $1.2 trillion and $1.5 trillion. Interestingly, both debt ceiling increases are subject to a vote of Disapproval by Congress. Members of Congress typically do not want to vote to increase the debt ceiling, so these increases will automatically occur unless Congress disapproves of them. And even if they are 'disapproved', President Obama can veto the vote and still increase the debt limit.

But is this deal, struck in the final hours before the default deadline, really congresses best effort? Are the cuts real or just 'non-increases'? Will government spending reverse course or will this prove to be simply a pause in a further march toward bigger government?

The big boss, Frank Trotter was in Vancouver with Chuck last week, and sent me his eloquent view on the debt debate on his flight back home. Keep in mind that this was written on Friday, before any agreement was hammered out, but Frank's points are still valid, so take it away Frank:

As I wing my way back from the Agora Financial conference in Vancouver I have quite a few minutes to reflect. First up - Vancouver maintains its lead as the nicest major city out there. I've had the opportunity to travel quite a bit and every time I return to YVR it stays in the lead. Yesterday the sun was out under blue skies to highlight the ocean and mountains viewed over Stanley Park and the Lions Gate Bridge as I walked up from my Coal Harbor hotel to the Fight or Flight conference. Chuck and I did a tag team this time tossing some topics back and forth with Chuck playing Gracie to my flat delivering George.

One topic that headed our list was the Great Debt Limit Debate of 2011. The surreal element to the debate is that it's really about nothing. We're living in a world of security theater and of course we can remind ourselves it's political theater as well. I had searched the news outlets for a listing of cuts from anyone's plan to no avail and instead headed over the CBO website where I found the Reid and Boehner proposals in detail. I'll admit I wasn't surprised to read what was there. Neither plan contains any significant cuts until after the 2012 election and any true gain is found in the last 5 years of each plan - what a concept. There are no paragraphs committing congress to these plans and of course they could change next week with just a vote. For me they are DOA.

Even though you didn't ask for it my two Pfennigs is that spending cut negotiations need to focus on reducing the Federal Government's role in the economy from about 25% today toward 10% by 2030. That is a ton and it must include cutting social security significantly (why should I get a last ditch support program payment - go read the 1930's speeches?), Medicare and Medicaid, the imperial military, and changing the philosophy of government towards privatization. I'll bet the interstate system would fetch a pretty Pfennig if sold to toll operators, and of taking up Cato's 1997 call for privatization of the mortgage business would likely create a more rational approach to housing. I could go on but the plane is finally letting down - as always it's a great day at EverBank!

Chris again. I agree with Frank (and not just because he signs my paychecks). I haven't been able to read all of the details of this agreement, but entitlement reform was definitely not included in any of the 'quick summaries' which have come across the news wires. While any cut to government spending is a start, the elephant in the room is the social welfare programs which will have to be restructured or cut along with the military cuts. Frank's calls for privatization are a bit tougher for me to accept, but I agree that the revenue side has to be addressed also (and alternatives to just raising taxes will need to be investigated).

The US debt deal boosted stock prices in the Asian-Pacific stock markets, with Japan's Nikkei and Australia's S&P/ASX indices gaining close to 2%. European stocks are also up this morning, but any gain will probably be muted by the shift of investor focus from the US debt crisis back to the European one.

The Euro has enjoyed being out of the spotlight for the last few weeks, and closed out July with only minor losses when compared with the US$. While a crisis looks to have been averted again in Greece, concerns over Portugal, Ireland, and even Spain persist. As we have pointed out several times in the Pfennig and our monthly Review and Focus publication, the European debt crisis will continue to hang over the Euro like the Sword of Damocles, limiting any real potential for appreciation in the single currency.

An article in the Economist magazine suggests a way out for European leaders. The magazine states that Europe's debt crisis seems to be leading Europe toward a deeper fiscal union instead of splitting it up. The magazine's Charlemagne columnist suggests Eurobonds could be seen as a cheaper alternative to further bailouts. What is being suggested is that the EU issue bonds backed by all of their members as a way to allow the peripheral countries to raise capital. This would require an EU treaty and perhaps an amendment to Germany's constitution. "Much depends on the course of the crisis: if it rages on, more people may come to see Eurobonds as cheaper than more bail-outs," Charlemagne wrote on July 30th.

Indications of a US debt ceiling increase has given a green light for risk trades, and the higher yielding currencies are all moving up this morning. While investors were flocking to the Swiss franc and Japanese yen last week, the currencies of New Zealand and Australia are looking a bit more attractive to them now.

The Japanese yen fell the most in four months in overnight trading and the New Zealand dollar rose to another record. Both the kiwi and the Australian dollar were helped by a report which showed faster than estimated manufacturing growth in China. The Purchasing Managers' Index for China's manufacturing was at 50.7 in July, more than every forecast in a Bloomberg News survey of 13 economists.

In contrast, US manufacturing is a bit worse than economists predicted. The Institute for Supply Management's index for US manufacturing is projected to fall to 54.5 in July from 55.3 in June. The index will be released later this morning along with Construction spending which is expected to show a slight rise. Tomorrow we will get reports on Personal spending and income along with US vehicle sales. Wednesday we get the ADP employment numbers along with Factory orders, and Thursday we will see the weekly jobs data. Friday will close the week out with the release of the Monthly job data for July along with the Unemployment rate.

It will certainly be a busy week of data releases here in the US which should give me plenty of Pfodder for the Pfennig. And to keep things even more interesting, the ECB will be meeting this week to set rates. If not for the uncertainty in the markets following the US debt debate, the ECB could have looked to raise rates. But now I believe they will probably leave them alone for now, and push any increase into the future.

Then there was this: The World Bank's International Finance Corp. unit priced the biggest offering in Australia by a foreign issuer in more than a year. The debt which is appropriately called 'Kangaroo' bonds was issued by the Washington based IFC and totaled A$1.5 billion ($1.65 billion). The issue shows just how much demand there is for top rated bonds denominated in currencies other than the US$ or Euros. With the sovereign debt crisis and continued debate over raising the US debt ceiling, these Kangaroo bonds promise to keep jumping off the shelves (couldn't resist).

To recap. A debt agreement will be put to a vote today, and all indications is that it will pass. The Big Boss Frank shares his views on what our Congress needs to do to make a real dent in the deficts and debt. The Euro has benefitted from a lack of attention, and closed out July with just a small decline vs. the US$. A$ and the kiwi benefitted from a move back to risk and good news on China's manufacturing, and it is shaping up to be a busy week for data in the US.

Currencies today 8/01/11 American Style: A$ $1.106, kiwi .8815, C$ $1.0518, euro 1.4432, sterling 1.6418, Swiss $1.2714. European Style: rand 6.6584, krone 5.3381, SEK 6.2459, forint 185.26, zloty 2.7571, koruna 16.7415, RUB 27.5368, yen 77.04, sing 1.2001, HKD 7.7918, INR 44.089, China 6.4339, pesos 11.6478, BRL 1.5493, dollar index 73.655, Oil $96.80, 10-year 2.82%, Silver $39.315, and Gold $1,617.40

That's it for today. I had a very busy (and hot) weekend working around the house. My mother's side of the family is coming into town later this week for our tri-annual family reunion. We are hosting everyone on Friday night for a barbeque and indoor games modeled after the games on 'Minute to Win it'. Should be fun, but my wife Tina wants everything perfect for the party. It sounds like the heat is going to stick around for most of the week, so I'm not sure why she had me working so hard on outside, I guarantee no one will venture outside with triple digit heat! Hope everyone has a great start to their week and a Marvelous Monday! Thanks for reading the Pfennig.

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 08-01-2011 11:18 AM by Chuck Butler