Yen moves higher as the BOJ begins their two day meeting...
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In This Issue.

* Yen moves higher as BOJ begins their meeting...

* Bank of England raises growth projections...

* German factory orders a positive sign for eurozone...

* Gold continues to drift lower...

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

Yen moves higher as the BOJ begins their two day meeting...

Good day. And welcome to hump day. The week is chugging along at a pretty good clip for me. It is kind of nice to stay in one place for a full week and not have to worry about dealing with delayed flights and long TSA lines. The dollar didn't go much of anywhere yesterday as currency traders digested the latest move by the RBA and awaited some direction from the Bank of Japan who started their two day meeting today.

August is only a week old, but thus far it has been a good one for currency investors. The US dollar is down against every major currency except the Canadian dollar. The best performer over the past 7 days has been the Japanese yen which rose to the highest level in almost 7 weeks vs. the greenback. The Bank of Japan has begun their two day meeting, and currency traders are beginning to place bets that Japan's central bank will refrain from increasing the already massive amount of stimulus which it has been pumping into the markets.

The Bank of Japan redoubled its stimulus efforts back in April, promising to double its bond holdings and boost purchases of assets in an all out effort to get inflation up to 2 percent over the next two years. And during their July meeting, while other major central banks were discussing a possible 'tapering' of their stimulus programs, BOJ officials indicated they would continue their aggressive purchases of long term debt at the current annual pace of 60 - 70 trillion yen per year.

Inflation finally crept back into the Japanese economy last month, with June CPI being reported at .2%. This was the first positive YOY change in prices in over a year. Some currency traders believe that this positive CPI number will encourage BOJ policy makers to leave the current levels of stimulus unchanged. While I don't think the BOJ will make a bid announcement like it did in April, I also don't think they are ready to start any talk of tapering their stimulus programs, so this rally in the Japanese yen will probably be short lived.

The other big mover in the currency markets overnight was the Pound sterling which has risen over 2% vs. the US$ during the first week of August. New central bank Governor held a press conference yesterday to give the markets some guidance on future BOE policy. The Bank of England raised their GDP growth projections for both 2013 and 2014, expecting 1.5% and 2.7% growth in each respective year. Carney suggested the 7 percent level for unemployment is a threshold and not a 'trigger' which would automatically begin a reduction of the stimulus programs. Instead, officials of the Monetary Policy Committee will begin to reassess the QE program once employment improves to that point.

A report released yesterday showed UK industrial production beat forecasts in June, climbing 1.1% after stagnating for the past three months. Another report showed factory output in the UK jumped 1.9% last month, also beating economists projections. But in spite of the positive economic data which has been filtering out of the UK, BOE officials said they still stand ready to expand their quantitative easing program if needed.

Sounds like QE is here to stay for a while in both England and Japan; and I believe the US will probably keep their bond buying at current levels through the end of 2013 also. The industrialized world has become addicted to stimulus, and all of these major central banks want to wait until they are absolutely sure their economies are strong enough to withstand the 'withdrawal symptoms' which they know will accompany the eventual tapering of stimulus.

The euro traded above 1.33 and remained there during early European trading after a report showed Germany's factory orders rebounded in June. German factory orders, adjusted for seasonal swings and inflation, increased 3.8% from May easily topping analysts' expectations of a 1 percent rise for June. The data supports the view that the Euro region is moving back in a positive direction. Last week, ECB President Mario Draghi suggested the 17 nation euro area was finally in a nascent recovery after surviving 6 straight quarters of contraction.

Moving back across the pond, data released yesterday showed the US trade deficit narrowed during the month of June. The trade deficit decreased from an adjusted $44.1 billion in May to a $34.2 billion shortfall in June. Most of this move was due to a combination of the big drop in the value of the dollar which we saw during the last couple of weeks of May and a reduction in oil imports.

The US also held an auction of $32 billion three year notes which drew the most demand in over two years, mostly from foreign investors. I still find it hard to believe that investors are lining up to purchase three year debt at rates of just .631%. I guess these investors realize that global interest rates probably aren't going much of anywhere in the short term.

China's reminmbi rose to a 19 year high on the fixing last night as the PBOC boosted the reference rate. The currency bumped up against its top band after a front page commentary in the Financial News (published by the central bank) said China "should make monetary controls more coordinated and use multiple tools to ensure stable and moderate credit growth." Another signal that China is moving toward more open financial markets as their economy continues to mature.

As I mentioned in the opening paragraphs, the Canadian dollar is the only currency which hasn't appreciated vs. the US$ during the past week. Lower commodity prices, and a slowing recovery has put pressure on the loonie. A report yesterday showed Canada continues to run a trade deficit, though it narrowed slightly last month. May's trade gap, which was C$469 million, was the 18th in a row for a country which has traditionally been a net exporter of raw materials. The global slowdown is being blamed for the drop in Canadian exports, and has contributed to a drop in Canadian GDP from 2.5% in the first quarter to an expected 1.6% in the second. With commodity prices remaining under pressure, I don't expect to see the Canadian dollar rebound in the short term.

Gold continued to slide and moved down to a three week low as investors speculated that the Fed will start to reduce bond purchases in the next few months. Fed Bank of Chicago President Charles Evans was the latest Fed Head in the news and said yesterday that there has been "good improvement" in the labor market suggesting a tapering in September is still possible. Traders in the shiny metal have been reducing their positions as a possible reduction in QE has been discussed. I still don't believe the Fed will start to taper at their September 17th meeting, but obviously a lot of traders still think it will happen and that has helped to push the price of gold lower over the past three months.

Then there was this. Chuck is still down in Florida enjoying some time with his family, but he sent me something he found over the weekend on the Drudge Report which I thought was perfect for our TTWT section. The title of the article, 'Bond Losses at Federal Reserve Top $192 Billion' certainly grabs your attention and here are some of the key points:

"At the end of July, the Federal Reserve held $1.98 trillion in U.S. Treasuries. (See chart below) That figure represents just over half of the Fed's $3.6 trillion balance sheet.

Scott Minerd, the Global Chief Investment Officer at Guggenheim Partners notes:

"Our estimate shows that the spike in bond yields since the first quarter of this year has caused a mark-to-market loss of $192 billion on the Fed's holding assets, equivalent to approximately all of the unrealized gains that the Fed had accumulated since it began to implement quantitative easing in late 2008. Although in keeping with their own accounting principles the Fed does not record mark-to-market losses, a continued increase in bond yields would incur actual losses should the central bank decide to sell assets."

"Granted, the Bernanke & Co. does not value its massive bond portfolio on a mark-to-market basis. But the surge in interest rates has already erased almost $200 billion in the Federal Reserve's capital. But that's not all.

If interest rates continue to head higher, the value of the Fed's liquid assets that it could sell would decline and further undermine its capital cushion. And if the velocity of rate increases intensifies, the Fed, with only $62 billion in capital, could see its entire capital base completely wiped out.

This could have a serious domino effect. It could paralyze the Fed's ability to defend the dollar's purchasing power, causing Treasury prices (NYSEARCA:TLT) to fall further and thereby push interest rates even higher. Just imagine the unimaginable; a weakened and impotent Fed."

Chris again. Yes, rates are certainly going higher, and with the Fed owning such a massive amount of bonds the losses will continue to mount. And this doesn't even consider what the higher rates will do to the debt service on all of this debt - it moves exponentially higher! You can read the entire article by clicking on the following link:$192-Billion/ .

To recap. The Japanese yen moved higher as currency investors predict the BOJ will take a more neutral tone during their 2 day meeting. The pound sterling moved higher as BOE officials increased their GDP growth projections and data showed the UK economy is improving. German factory orders surprised on the upside, supporting the euro. China pegged their currency at a 19 year high, and the Canadian dollar falls as a result of lower commodity prices. Gold slid lower on tapering thoughts, and Chuck shared an article for our TTWT section.

Currencies today 8/07/13. American Style: A$ .8933, kiwi .7894, C$ .959, euro 1.33, sterling 1.5441, Swiss $1.0798. European Style: rand 9.9221, krone 5.9382, SEK 6.5637, forint 225.17, zloty 3.1708, koruna 19.5376, RUB 33.002, yen 97.31, sing 1.2673, HKD 7.7562, INR 61.34, China 6.1726, pesos 12.644, BRL 2.2991, Dollar Index 81.588, Oil $105.17, 10-year 2.63%, Silver $19.3195, Platinum $1,419.15, Palladium $714.95, and Gold. $1,277.50.

That's it for today. Thanks for all of the suggestions on the raccoon, and I'm happy to report we didn't lose any tomatoes last night so I think the problem is solved (for now). It was a beautiful sunrise this morning, but the clouds have rolled in now and it is looking like we will get some rain today. I heard on the news last night that three of the big Mizzou stars currently playing in the NFL have been hurt during their respective training camps, bummer! The Cards were finally able to get a win last night, and pulled back within 2 games of Pittsburgh. Hope everyone has a happy hump day and Wonderful Wednesday. Thanks for reading the Pfennig!

Chris Gaffney, CFA
Vice President
EverBank World Markets

Posted 08-07-2013 3:59 PM by Chuck Butler
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