Budget gap to approach $500 billion...
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In This Issue..

* Budget gap to approach $500 billion...

* Deficits lead to record borrowing by the US...

* Commodity currencies take divergent paths...

* India raises rates...

And Now... Today's Pfennig!

Budget gap to approach $500 billion...

Good day... The currency markets were mostly flat yesterday with all of the majors stuck in fairly tight trading ranges. With no economic data released, the trading desks were mostly dead. The story which dominated the screens yesterday was the announcement of a record $490 billion US budget gap. The Bush administration said the US budget deficit will widen to a record next year, leaving a deep budget hole. The bigger shortfall reflects dwindling tax receipts because of the US economic slowdown, the cost of the $168 billion economic stimulus package and spending on the wars in Iraq and Afghanistan.

The shortfall reflects a deterioration of the budget over the past seven years. Bush inherited a budget surplus of $128 billion when he took office in 2001. The budget worsened almost immediately, because of recession, the Sept 11 attacks, the beginning of the war in Afghanistan and, later, the war in Iraq.

Believe it or not, the current projections still understate the deficit next year because the administration hasn't requested the money to prosecute the wars for the full year, leaving that to the next president. No matter which presidential candidate gets elected, their tax and spending plans will be severely constrained by these massive deficits.

With the announcement of the record US budget deficit, it should come as no surprise that the US Treasury predicted it would borrow 53 percent more this quarter than initially forecast. Borrowing needs will rise to $171 billion in the three months to Sept. 30, $59 billion more than predicted in April. I guess the good news is that total, if realized, is still slightly smaller than the $244 billion borrowed in the first three months of this year.

The situation here is bad and seems to be getting worse. The major question remains: Who will be standing in line to purchase all of this debt? And what happens to the dollar if/when foreign investors decide they have enough IOUs from the US Treasury and need to be enticed to purchase more. The result will be higher rates here in the US as fewer buyers will demand higher interest to encourage them to purchase the new debt. Another way for the US to entice foreign investors is to lower the value of the US$ in order to make these new Treasury securities cheaper to purchase. I believe we will likely see a combination of the two, higher rates along with a falling US$.

Our friend over at 'The 5 Min. Forecast', Ian Mathias, dug into the new housing rescue bill approved this weekend and found our elected representatives used the measure to increase the debt ceiling. Here is what Ian wrote yesterday afternoon: "Hmmm. and isn't this interesting: Congress snuck a dramatic hike of the federal debt ceiling into the approved housing rescue. When the bill is signed to law, the federal debt "limit" will be hiked $800 billion, to $10.6 trillion. Funny, last week the Congressional Budget Office estimated the Fannie/Freddie rescue would cost $100 billion, at most. Coupled with the rest of the housing rescue, Congress has given themselves a $400 billion cushion. wonder why?

(Not a peep on this matter from CNBC today, by the way. They spent the whole morning teasing the winners of their million dollar stock trading challenge.)"

The 5 is always a great read, as Ian does a great job of taking the days big stories and boiling them down to the juiciest bits. You can read all of The 5 and also look at past issues by going to agorafinancial.com/5min.

A story in this weeks Economist magazine really demonstrates the possible impacts of runaway inflation. Zimbabwe, which has been experiencing hyperinflation and is mired in a political and economic quagmire recently introduced a new banknote. Last week Zimbabwe's central bank unveiled a 100 billion dollar banknote to cope with inflation. That is a bank note with 11 zeros!! But as crazy as this sounds, the Zimbabwe dollar banknote still doesn't hold the all time record. A note issued in post-war Hungary came with a mind-boggling 19 digits! While thankfully the US is not yet in this type of situation, the situation in Zimbabwe and post-war Hungary should be a reminder of what can happen in a country if the central bank continues to ignore inflation.

The only real movements by currencies yesterday came from the commodity based currencies of New Zealand and South Africa, but surprisingly they moved in opposite directions. These movements were mainly due to opposing views on interest rate directions. The Reserve Bank of New Zealand cut interest rates for the first time in five years last week and Governor Bollard said the bank "would expect to lower rates further." On the other hand, the South African Rand rose for a second day on bets accelerating inflation will prompt the central bank to boost interest rates. The Rand was the best performer against the US$ as carry flow trades have recently moved from the kiwi over to the rand.

Another benefactor of expected interest rate increases was the Brazilian Real which traded near a nine-year high on interest rate speculation. The central bank has signaled it won't let inflation get out of control as it increased the target rate for the second time in three meetings last week. With commodity prices holding steady, inflation is expected to continue to accelerate. But gains in the currency were pared after the central bank said Brazil posted a record current account deficit in the first half of the year. The six-month deficit rose to $17.4 billion in the first six months of 2008 compared to a surplus of $2.41 billion in the same period last year.

India's central bank increased its benchmark interest rate by a half point, more than economists predicted, and forecast slowing economic growth as inflation at a 13 year high erodes spending by consumers and companies. Unfortunately, the rise in interest rates didn't help the currency, as investors worried about a slowdown in growth. Standard $ Poor's announcement that they may be cutting India's BBB- credit rating also caused concern for currency investors.

As I finish writing the dollar has gotten some strength and it looks like the Euro could lose the 1.57 handle. Don't think this quick dollar bounce will last, as the housing and consumer confidence numbers released later this morning should throw cold water on the US$.

Currencies today 7/29/08... A$ .9575, kiwi .7403, C$.977, euro 1.5739, sterling 1.9917, Swiss .9676, ISK 81.43, rand 7.483, krone 5.1303, SEK 6.0037, forint 146.79, zloty 2.0444, koruna 15.08, yen 107.59, baht 33.49, sing 1.3648, HKD 7.8018, INR 42.57, China 6.8256, pesos 10.05, BRL 1.5757, dollar index 72.71, Oil $125.05, Silver $17.48, and Gold... $928.96

That's it for today... It has been a busy month on the trading desk. We continue to keep up a very busy pace of new account opening and the phone calls keep rolling in. And with Chuck and Frank on the road 'spreading the good word' I don't expect them to slow up anytime soon. As Frank likes to say, Onward and Upward!! Hope everyone has a terrific Tuesday!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 07-29-2008 9:38 AM by Chuck Butler