Governor Stevens and the RBA surprises the markets...
Daily Pfennig

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    In This Issue..

    * Dollar slides as risk returns...
    * RBA surprises the markets...                                                                                 
    * Gold moves higher...                                              
    * Obama offers up record deficits...                                                                                                       

    And Now... Today's Pfennig!

    Governor Stevens and the RBA surprises the markets...                                            

    Good day... And a happy Ground Hog day to everyone!  Yes, today is the day Phil decides if we are going to have more winter weather or a quick spring.  While I can find something to like during all of the seasons, I do find myself hoping we see a quick end to the cold weather as we turn the calendar over to February.  Unfortunately, the folks who make a living predicting the weather don't believe we will get an early spring this year, but their record is about as good as Groundhog Phil's, so we will just have to wait to see what Mother Nature brings us.  Kristin and I will be joining Chuck down in Orlando tomorrow, so hopefully a few days of warm weather will hold me over until April.

    The currency markets warmed up a bit yesterday, as investors gained confidence and moved funds back out of the 'safe haven' of the US$.  The main driver of investor confidence was the ISM Manufacturing Index which expanded in January at the fastest pace since August 2004.  The index rose to 58.4 in January from December's 54.9 level.  Any reading above 50 signals expansion in the US manufacturing sector.  The surprising strength of this index had investors shifting funds back into the higher yielding assets yesterday, and selling dollars.  Chuck sent took a look at the ISM numbers yesterday, and sent me the following on his way out the door:   

    "Of the data yesterday, I wanted to highlight something... The ISM Manufacturing Index for January came in much stronger than expected, at 58.4 (55.5 was the forecast)... Now... It certainly looks like the rot on the Manufacturing Vine is healing... But what happens if the dollar rally continues, and... Exports get deep sixed? Only you know and I know... All the lovin we've got to show... So don't refuse to believe it... By reading too many meanings...

    Yes... A strong dollar doesn't necessarily help Manufacturing... But then, if your country really makes things that the rest of the world wants, then it makes no difference how strong your currency is... But... If you're out there pleading and begging with people to take your exports, then the value of the currency is very important... I think we all need to remember that... (of course it would be more helpful if traders remembered that!)"  I always appreciate Chuck leaving me his thoughts on the way out the door, and I think he is bang on regarding the recovery in the manufacturing sector. 

    The rest of yesterday's data here in the US seemed to confirm an improving US economy; with consumer spending increasing for a third straight month.  As Chuck pointed out yesterday, we can't have much of a recovery here in the US without a strong consumer; and with unemployment expected to hold at double digits for the entire 2010, a strong recovery is questionable.  But investors weren't worried about the long term yesterday, and instead trumpeted the higher consumer spending numbers as a sign the US economy would continue to strengthen. 

    With stronger data releases in the US, the dollar lost ground.  Yes, we are back to the old trading pattern where good news for the US economy means bad news for the dollar.  When investors feel a bit more confident about the recovery here in the states, they start to look for higher returns.  This means they can sell their 'safe haven' holdings of low yielding dollars and move the funds back into higher yielding currencies and investments. 

    While the dollar lost ground generally, the one currency which was having trouble appreciating yesterday was the Aussie dollar.  Late yesterday afternoon traders began to price in the possibility that the RBA would pause, and not raise rates.  Overnight, they did just that, with RBA Governor Glen Stevens surprising the markets by keeping rates steady.  The move surprised economists, who had been unanimous in their prediction of a .25% increase.  The Australian dollar slid dramatically as investors moved funds out of the A$ and into other higher yielding currencies.  AUD moved through the 88 cent handle immediately following the rate announcement, but then managed to climb back up above in European trading.  But the worst may not be over yet, as many currency traders are now predicting a drop to 85 cents if the markets begin to bet on an early increase in US rates by the Federal Reserve.  But neither Chuck nor I believe the Fed will have the cojones to raise rates with double digit unemployment here in the US.  And the pause by the RBA is just that, a pause!  It is not a change in the direction of future interest rate moves.  The RBA will come back to the rate table with another increase, and last nights action will be quickly forgotten.  While the Aussie dollar may drift lower, any move back into the 87 cent handle should be seen as an excellent buying opportunity.

    Two of the currencies which benefitted the most from the sell off by the AUD$ were the South African rand and the Norwegian krone, both of which increased vs. the US$.  The Norges bank will be meeting tomorrow and had been expected to keep interest rates steady in Norway.  But last night's surprise move got the traders primed for more surprises, and some are now pricing in the possibility that the Norges bank will look to raise rates.  I am still with Chuck on this one, and don't expect any surprises out of either the Norges bank or the ECB which will conclude their meeting Thursday. 

    The South African rand climbed to the highest level in almost two weeks as investors were attracted by the yield differentials which are some of the widest in the developed world.  The rand also benefitted from a strong move by gold yesterday.  Gold is South Africa's biggest export earner so the $25 move in prices helped boost demand for the rand.  Investors looking to diversify out of the US$ are shying away from the problems with the Euro and are increasingly looking toward the commodity based currencies of South Africa, Norway, Canada, and even the Brazilian real.

    Speaking of the real, it looks like it may finally be bottoming out.  A news report which I read last night stated that options traders are dropping their bearish bets against the Brazilian real at the fastest pace since April.  Another item helping the real overnight was a report released by Goldman Sachs Group Inc. who recommended investors buy Brazil's currency.  "Brazil's growth has remained strong and is accelerating," a research note to clients stated.  Goldman predicts the currency will rally from the current levels to 1.75 in the medium term (an increase of 5.5%).  With one of the highest interest rates we currently offer, the Brazilian real may deserve another look for the speculative dollars in your currency portfolio.

    While the currency traders were focused on the surprise announcement out of Australia, and continuing problems in Greece, most of the news stories here in the US revolved around President Obama's proposed budget.  As you have probably already read or heard, the 2011 budget calls for $100 billion in additional stimulus spending which will push the projected deficit to a record $1.6 trillion.  His plan also calls for $800 billion in higher taxes on those earning more than $250,000 and additional fees on banks that got bailed out by the taxpayers. 

    As part of this budget proposal, the Obama administration also released their forecasts for unemployment and GDP.  The administration has had to adjust their predictions for unemployment, admitting that their earlier predictions of a rate below 10% were too optimistic.  They now predict the rate will average 10% during 2010, and will remain above 6% through the next 5 years.  We all know the real unemployment numbers are substantially above this 'official rate' and I believe these high jobless numbers will keep the US economy from recovering in the near term.

    But the administration still believe we are going to have a strong 'jobless' recovery!  While they adjusted their forecasts for unemployment, they actually increased their prediction for GDP in 2010 to 2.7% from their previous prediction of 2%.  They also kept their call for a 3.8% increase in GDP for 2011.  Just what are the boys in Washington smoking?  Do they honestly believe we are going to see a very strong GDP recovery with unemployment staying in double digits?  Chuck and I sure aren't buying into their rhetoric.  Here is another note he left me yesterday:

    "Don't think the hard assets crowds weren't freaked out by the President's Budget Proposal yesterday? Gold shot up $25, before I went home for the day! That's the best 1-day performance for Gold in a month! And the Budget Proposal got others thinking too, that maybe, just maybe the dollar rally has stalled...

    I don't know about you... But as far as I'm concerned, these budget deficits are giving me a rash! Remember when I used to bang on the previous administration when they would book $350 Billion Budget Deficits? I thought that was unsustainable... And it proved to be! Now they are $1 Trillion and more each year! I did see that $100 Billion of that Budget is another "stimulus"... The Jobs Bill that I talked to you about yesterday... Great, just great! We've become Japan, circa 15 years ago..."

    The deficits in the US are definitely unsustainable, and will eventually force action by the administration.  Unfortunately, the markets aren't as easy to fool as the news media, and our administration will not be able to continue to push out the 'judgment day'.  We will likely see our interest rates forced higher, as the printing presses continue on overdrive in an attempt to 'inflate away' our growing debt.  The ultimate consequence of these massive deficits will be a much weaker currency, and higher interest rates.

    On that cheery note, I will head to the currency wrap-up:

    Currencies today 2/2/10: American Style: A$ .8818, kiwi .7083, C$ .9462, euro 1.3941, sterling 1.5923, Swiss .9467, European Style: rand 7.4682, krone 5.8475, SEK 7.2501, forint 193.37, zloty 2.8631, koruna 18.609, RUB 30.16, Yen 90.66, sing 1.4094, HKD 7.7675, INR 46.235, China 6.8271, pesos 12.87, BRL 1.8396, dollar index 79.18, Oil $75.27, 10-year 3.66%, Silver $16.73, and Gold... $1,115.02

    That's it for today... Chuck is on his way to Orlando for the big Money Show at the Gaylord Palms.  Over the several years we have been attending the show, Chuck has steadily built up quite a following.  I can remember when we had trouble filling up small rooms for one or two presentations, but this year Chuck and Frank will be giving 5 presentations with hundreds of people attending each one.  Both Kristin and I will be heading down tomorrow afternoon, and I've got to say I'm looking forward to a bit of warm weather!  Got to run now, as the quarterly officers meeting is getting underway.  I hope everyone has a Terrific Tuesday, and a Great Groundhog Day!!

    Chris Gaffney, CFA
    Vice President
    EverBank World Markets

    Posted 02-02-2010 10:13 AM by Chuck Butler