Agreement is reached, and dollar pops up.
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In This Issue.

* House agrees on debt rise...

* Swiss franc continues to shine...

* RBA leaves rates unchanged ...

* India needs to raise rates...

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

Agreement is reached, and dollar pops up.

Good day. And welcome to August 2nd, DC (Debt Ceiling) day here in the US. The agreement which was negotiated over the weekend made it through the house late yesterday and will head over to a more accepting Senate today. President Obama will probably sign the bill into law sometime this evening ending the long debate over deficit spending in our nation's capitol. Notice that I didn't say we were ending the deficit spending; that will continue for the foreseeable future. And in fact the debate is far from over. The committee which will be established as part of this bill will need to come up with additional spending cuts by Thanksgiving which means the deficits and debt will continue to be the talk of DC. And the next round of cuts won't be so easy for Congress to agree on, as they will certainly include changes to the all mighty 'entitlement programs'. Military spending and entitlement programs are where the bulk of spending is located, and will have to be where significant cuts are made.

I figured the dollar would rally on any debt ceiling deal, and it did rally pretty dramatically vs. the Euro in overnight trading. The Australian dollar dropped the most, shaving over 1% off of its value vs. the US$ (more on the Aussie later in today's Pfennig). The Euro and a majority of the other major currencies were down right around .5% vs. the US$ as investors were relieved by the debt ceiling agreement. The dollar probably would have risen even more if not for the manufacturing data which was reported yesterday morning.

Manufacturing in the US was basically flat in July, with the ISM's factory index slumping to 50.9, the lowest since July 2009. This was well below the expected level of 54.5, and a dramatic drop from last month's 55.3 reading. Figures less than 50 denote a contraction in the manufacturing index. Other data released yesterday indicated a global slowdown as manufacturing shrank in the UK, Russia, and Australia. And while Germany and Asia continue to be the manufacturing centers of the world, factory growth also slowed in both Europe and China. Global consumer confidence has taken a hit by the European debt crisis, the possible downgrade of the US debt, and an increase in Chinese interest rates.

And the data which will be released this morning in the US isn't expected to brighten the mood. Consumer spending in the US is expected to have stalled in June as continued high unemployment weighs on US households. Personal Income is expected to have risen .2% in June with Personal spending eking out a .1% gain. Tomorrow we will get another look at the state of US manufacturing with the Factory orders for June which are expected to have fallen .8%.

By all indications, the US economic recovery is stalling (again) and the debt ceiling debate which has gripped Washington over the past few weeks will make it even harder for President Obama to do anything about it. Not that I think another round of stimulus is what is needed right now, but I would guarantee that is exactly what the administration would like to be able to provide. The former chairman of President Obama's economic advisers, Christina Romer, believes the risk that the US economy will lapse back into a recession has increased dramatically. Romer still doesn't believe that is where we are headed, but does think it is a bigger risk today than it was 6 months ago.

Federal Reserve Chairman Ben Bernanke has largely stayed out of the fray, but the Fed policy makers will have to start weighing options on how to prop up growth in the US as economists continue to cut their growth forecasts. The FOMC will meet next week, with a rate decision expected one week from today. The debt ceiling deal will be a drag on the US economy in the short run, as lower government spending and invariably higher taxes will take a toll on US growth. But this is exactly the 'tough medicine' which Chuck and I have been calling for. Continued deficit spending, while good for the short term, would simply make the pill even harder to swallow in the future. That is again one of the silver linings of this protracted debt ceiling debate; we are finally facing the music and will be forced to start making cuts. But it certainly doesn't make the Fed's job any easier. I'm sure Bernanke would love to just abandon the Feds 'dual mandate' and focus on keeping inflation at bay. But his buddies over on Wall Street certainly wouldn't like that, and are relying on Bernanke to keep the stock markets moving higher.

One country which seems to have everything going their way lately is Switzerland. The Swiss franc was the best performing currency through the debt crisis of Europe and the US. And the franc continued to appreciate even after an apparent agreement was reached in Washington DC. The Swiss franc was the only currency to strengthen vs. the US$ in the past 24 hours, and is now up close to 20% during 2011.

Two recent reports showed the economy of Switzerland seems to be bucking the global trends, with increases being reported in both retail sales and manufacturing during the previous period. But all good things must come to an end, and the speed of the Swiss franc's rise is certainly worrying. While I continue to believe the Swiss franc is a good solid currency to hold in a diversified portfolio, investors may want to look to 'reallocate' some of their Swiss francs in order to lock in these recent gains.

Two other top performers of the year vs. the US$ are the currencies from down under. The New Zealand dollar has been the second best performing currency over the past 6 months, rising 12.4% vs. the US$. A report released yesterday showed wages in New Zealand gained slightly last quarter, which is a good sign in an economy which was struggling to recover from the natural disasters of 2010.

The other currency down under, the Australian dollar, was mostly unchanged overnight after RBA policy makers left rates unchanged. The Reserve Bank of Australia policy makers suggested it was prudent to hold off any rate increase due to the clouded global economic outlook. Governor Glenn Stevens still sounded hawkish, saying "the board remains concerned about the medium term outlook for inflation." But the risk of a global slowdown still kept the RBA from deciding to move rates higher, and caused some to question whether we will see any rate increase in 2011.

We still believe the RBA will raise rates this year, and any increase would be good for the Aussie dollar. One of the reasons the Aussie dollar has been a long time favorite of the desk is their strong underlying economic fundamentals. While the US and Europe struggle with debt loads, public debt in Australia is only 22 percent of their economy in 2010, compared with 92% for the US and 80% for Germany.

One country where rates look like they will be heading higher is India, where a central bank Governor Duvvuri Subbarao said rates will need to be raised in order to tame inflation and sustain economic growth. The comments came just a week after India's central bank surprised the markets with a 50 basis point increase, the 11th raise since the start of 2010. "People say are you not hurting growth in order to contain inflation? Our response is that, we need to restrain inflation in order to ensure that our medium-term growth is sustainable," Subbarao told students at Gitam University yesterday. Well said!! India's economy probably expanded 7.2% in the year through March, a bit less than the original prediction of 7.7% according to an email from Morgan Stanley today. The prime minister's council projected 8.2% growth, but the multiple interest rate increases seem to be having the desired effect in lowering inflation and easing growth.

Finally, both gold and silver rallied in overnight trading, with silver rising back above $40 and gold increasing even more. Both of the precious metals have served as a good 'uncertainty hedge' during the debt ceiling debate, and continue to hold value even after the DC agreement. Volatility will continue, as global growth will be spotty and vary dramatically from region to region. Precious metals should continue to be an important part of an investment portfolio.

To recap. The house voted to pass the debt ceiling compromise, and it now moves on to a pretty certain passage in the Senate. The dollar rallied after the house vote, but global growth concerns seem to continue to weigh on the markets. The Swiss franc hit another record, and data suggests the Swiss economy is hitting on all cylinders. The RBA left Australian interest rates unchanged, and the Aussie dollar was largely unchanged after the announcement. India will likely continue to increase its rates after the central bank Governor said taming inflation is necessary to promote sustainable growth. And the precious metals continue to be an excellent 'uncertainty hedge'.

Currencies today 8/02/11 American Style: A$ $1.0855, kiwi .8731, C$ $1.0436, euro 1.4187, sterling 1.628, Swiss $1.2824. European Style: rand 6.7477, krone 5.3879, SEK 6.3452, forint 190.25, zloty 2.84, koruna 17.077, RUB 27.847, yen 77.39, sing 1.2047, HKD 7.7938, INR 44.276, China 6.4381, pesos 11.7812, BRL 1.5661, dollar index 74.549, Oil $94.21, 10-year 2.68%, Silver $39.7225, and Gold $1,628.10

That's it for today. My wife and kids are heading on an annual 'float trip' today. They will float down one of the beautiful rivers which wind their way through the hills just southwest of St. Louis. The outside temperatures are supposed to hit the triple digits again today, so I'm sure they will be spending a majority of the time out of the kayaks and in the water. I will be stuck inside the office all day again as we continue to try and polish our new WorldMarkets operating system. It has been going well lately, but we are getting close to the 'crunch time' for this new computer system. Christine has certainly helped to make my Tuesday terrific as she brought me a large latte from Starbucks!! Hope your Tuesday is terrific, and thanks for reading the Pfennig!!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 08-02-2011 10:11 AM by Chuck Butler