Risk aversion is so yesterday ...
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In This Issue.

* Risk aversion is a thing of the past...

* Some positive news for the US...

* ECB's President softens his hawkish tone...

* India continues to post good growth in spite of higher rates...

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

Risk aversion is so yesterday ...

Good day, Chuck's oral surgery hit a bit of a snag yesterday so he is taking a recovery day today. He texted me that everything will hopefully be alright, but decided that discretion is the better part of valor and decided to stay at home this morning while he is recovering. Frank had spoke to him earlier in the day and told me they have him on some pretty good painkillers which make him a bit loopy (probably not too much of a disadvantage for writing the Pfennig!).

Currency traders threw discretion (and risk aversion) to the wind yesterday as they moved out of the safe harbors of the Swiss franc, Japanese yen, and US dollar. Investors, buoyed by the optimism of world economic leaders in Jackson Hole Wyoming boosted equity markets, commodities, and the higher yielding currencies. Their moods were brightened even further by data released Monday morning which showed US consumer spending rose .8% during the month of July, the biggest gain since February. Incomes grew at a more moderate rate of just .3%, driving the savings rate to a four month low. The good news was moderated a bit by early predictions that the spending surge (if you can call a .8% increase a surge) will be reverse in August after consumer confidence nosedived following the S&P downgrade and subsequent drop in the equity markets.

There was one piece of negative data released yesterday, as the number of contracts to purchase existing homes in the US dropped for the first time in three months. July sales of previously owned homes fell 1.3% following a 2.4% increase in the month before. Economists had forecast a drop of 1%, so the news didn't have as big of an impact as it could have. Unfortunately a stubbornly high unemployment rate and large pipeline of future foreclosures will likely cause the US housing market to continue its struggle to recover.

But the markets were more focused on the here and now, and the positive data caused a nice pickup in global equity markets. Good news for the global economy helped boost commodity prices, and the currencies of those countries which produce oil and raw materials used for global production. The Canadian dollar was a benefactor of the new confidence, reaching a three week high vs. the US$. Bank of Canada Governor Mark Carney is sounding a more dovish tone as the Canadian economy seems to be slowing and could have even contracted in the 2nd quarter. Canadian economists have cut by half their expectations of another rate increase by the Bank of Canada through the end of next year according to a Bloomberg survey. Last month's survey showed these same economists projected Canadian interest rates would be a full 75 basis points higher than current expectations.

Our trading partners to the south also saw an increase in their currency as the Mexican peso added to the gains it made over the weekend. The US accounts for nearly 80 percent of Mexico's exports, so the positive consumer spending, and somewhat upbeat assessment of the US economy by Bernanke helped to boost prospects for the Mexican economy.

Reports out of Europe's largest economy yesterday showed inflation is slowing as seasonal food and energy prices fell in four German states. The overall German inflation decelerated to 2.4% YOY, slightly lower than economists had predicted. Another report released this morning showed confidence in the Euro area slid to 98.3 from a revised 103 in July. That is the lowest level since May of last year and well below economist's forecasts of 100.2. I don't know if it was because of the data or some arm twisting from the US Fed chairman, but ECB President Jean-Claude Trichet is sounding a bit softer when it comes to the risks of inflation. The ECB President, who seems to be drinking the Jackson Hole Kool-Aid, said the bank is reviewing its assessment of inflation risks as economic growth slows. The comments suggest the ECB may be looking to end the latest rate hiking cycle, and could mirror the US FOMC by keeping rates at current levels until 2013. This was not welcome news for euro holders, as they sold the common currency and went looking for better prospects.

Moody's finally had something positive to say about Europe today, praising Spain's plans for budget discipline. Prime Minister Jose Luis Rodriguez Zapatero's (what a name!) plan to place budget rules into the Spanish constitution has met with protests from trade unions. But Moody's, who placed Spain's credit rating review for a possible downgrade last month said the proposal shows 'broad consensus' on budget discipline. As we have written in past Pfennigs, a debt crisis in Spain could be the straw which breaks the back of the European Union, so a move toward deficit reductions is certainly welcomed by euro investors.

Both Spain and Italy have garnered the focus of bond investors looking for the next 'short' opportunity. While Spain got some help from Moody's, Italy will be testing the waters with a planned auction of 4.25 billion euros of 3 and 7 year debt. The ECB is restrained from purchasing the debt at auction, so Italy will have to attract buyers without the help of an ECB 'support bid'. While the ECB can still support the secondary bond markets, yields will be set by other investors during the upcoming auction. Italy is hoping the yields which the ECB has forced down with their secondary purchases will remain low during this first auction. Both Spain and France are also planning debt sales, so there is a lot riding on the success of this issue.

The Indian rupee gained the most in almost a month on speculation global funds will begin to move back into emerging market assets. The rupee increased in value after a report released early today showed gross domestic product rose 7.7 percent in the three months ended June 30. This compares with a 7.8% increase in the first quarter when compared to a year earlier. Bucking the trend of some other dovish central banks, the Reserve Bank of India said last week that consumption would remain strong because of higher salaries and inflation would likely remain stubbornly high. It certainly sounds as if the RBI will continue to hike rates, which should be good news for investors in the rupee.

Aussie dollars were also higher in trading yesterday, climbing to its strongest level in four weeks vs. the US$. A stronger global economy, and tick up in copper and other raw materials has helped boost the AUD$. Expectations of rate cuts, which were increasing over the past few months have now abated, and most of the markets believe the RBA will leave rates unchanged through the end of the year. Both Chuck and I believe we could still possibly see another rate hike if inflation pressures continue to grow.

Inflation worries certainly seem to be on the mind of Australia's largest export market, as Chinese policy makers said it is going to be difficult to keep inflation down. The People's Bank of China let their currency appreciate again overnight, setting the peg .05% stronger at 6.3849 which is the highest value since July of 2005. A statement posted on China's National Development and Reform Commission website stated that the overall price level will likely remain high. China has already used reserve requirement hikes to try and tame inflation, but a higher currency price is another excellent tool available to policy makers to contain inflation. While increases will continue to be contained, the latest news certainly indicates Chinese policy makers may be moving toward a more active use of currency appreciation to combat inflation.

And I will wrap up this morning's Pfennig with a quick story on Gold. The shiny metal dropped almost $75 during trading yesterday, but investors look to be taking advantage of the 'bargain' prices and are pushing the metal back up to near a 5 day high. The mood among gold investors seems to be 'buy on the dips' rather than chase the markets higher. Last week's dramatic sell off is quickly becoming a thing of the past, as Gold is again tracking toward $1,900. We could also see higher demand from India, which is the biggest user. We are entering the festival season in India, and experts are predicting a buying surge of as much as 25% above last year's festival demand. Silver traded down a bit yesterday, but recovered in early European trading and is again trading above $41.

To recap. Risk aversion becomes a thing of the past as investors are encouraged by Bernanke's Wyoming comments. US data showed consumer spending increased, but the savings rate slipped lower. Canadian rates are expected to mirror those in the US, but commodity price increases and positive news out of the US helped boost the loonie and the Mexican Peso. Spain got some good news from Moody's, and Italy will be testing the European bond markets this week. India continues to grow at a good clip helping the rupee, and the Aussie dollar also rallied on good growth prospects in India and China. Gold dropped yesterday, but investors flocked back into the shiny metal taking advantage of the lower prices.

Currencies today 8/30/11 American Style: A$ $1.0634, kiwi .8488, C$ $1.0211, euro 1.4404, sterling 1.6324, Swiss $1.2182. European Style: rand 7.0702, krone 5.3908, SEK 6.3766, forint 189.08, zloty 2.8847, koruna 16.734, RUB 28.954, yen 76.80, sing 1.2081, HKD 7.7947, INR 46.0938, China 6.3807, pesos 12.4843, BRL 1.5914, dollar index 74.144, Oil $86.69, 10-year 2.21%, Silver $40.89, and Gold $1,792.40

That's it for today. I spent part of last night used car shopping, not my favorite thing to do. My son will be turning 16 next month, and like many 16 year old boys he feels like he needs to buy a Jeep. My wife and I encouraged him to save money from an early age, and agreed to match any money he saved to purchase a vehicle when he turned 16. Long time readers may recall a story I shared years ago about how my son took a real interest in Gold and Silver after I visited his 4th grade class and gave them a presentation on money. After listening to my presentation, Brendan asked me to invest his savings into Gold and Silver, but hearing a comparison of how much Silver he could get vs. Gold he decided to just stick to Silver. Well he invested into Silver at just under $10, and he is really appreciating what the four fold increase has done for his 'car fund'. While we won't let him purchase exactly what he wants (a wide open Jeep Wrangler) he is definitely going to be driving a nicer car than I had in high school! With that I will bid you all a Terrific Tuesday!! Thanks for reading the Pfennig.

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 08-30-2011 11:47 AM by Chuck Butler
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