Misguided risk aversion...
Daily Pfennig

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In This Issue..

* Bad data pushes investors into US treasuries...

* Barclay's says the euro will rally...

* SNB surprises with a rate cut...

* Iceland gets their bailout...

And Now... Today's Pfennig!

Misguided risk aversion...

Good day...The dollar rallied a bit yesterday on some very poor economic data which illustrated just how bad things are getting here in the US. As Chuck has repeatedly told everyone, in the current trade pattern the dollar rallies whenever we get negative data for the US economy. Investors get spooked by this negative data, and run scared into the 'safety' of US treasuries.

Ty sent me a quote from respected newsletter owner/author Bill Bonner yesterday: "Misguided risk aversion, anyone? A few months ago, investors stretched for yields. Now, it's safety they reach for...and grab U.S. Treasury debt with both hands. Investors now seem to have an unqualified trust in the full faith and credit of the world's largest debtor. Yields on 91-day T-bills have fallen to 0.11% - scarcely a tenth of one percent!"

And when you adjust these yields for US inflation, the real yields on US treasuries are negative (even the 10 yr treasury real yield is -.43%!!). These investors won't be parked in US Treasuries for long, but while fear continues to drive the markets, the US dollar will remain strong.

The data which sent shivers down investors spines yesterday was a one two punch of weekly jobless claims and leading indicators. The number of Americans filing for unemployment benefits approached a 26-year high of 542,000 last week. The Unemployment rate will likely increase another 100 bps by this time next year, and stay at these elevated levels for an extended period of time.

The second blow came shortly after the jobs data was released, as the index of leading US economic indicators fell in October for the third time in four months. The Conference Board's gauge dropped .8%, more than forecast, after rising .1% in September. This index points to the direction of the economy over the next three to six months. Consumers and companies are cutting back as job losses mount and housing and manufacturing sink deeper into a slump. These two pieces of data indicate just how quickly the US economy is falling into recession.

Investors fled stocks and moved back into dollars throughout the trading day yesterday, rallying the dollar index back to the highest level since April 2006. We moved above 88 on the dollar index a week ago, but it was unable to maintain the higher level.

The same thing occurred last night, as equity markets in Asia rebounded, bringing the dollar index back below the 88 handle. Apparently there was speculation that a sale of Citigroup Inc. will reduce risk in the financial system, slightly increasing the confidence of investors. This is how perverse these markets have become; the possible sale of one of the largest financial firms in the US actually rallies the markets.

The European Union announced that is crafting a coordinated economic stimulus package to spur its 27 nation economy. European Commission President Jose Barroso told reporters in Brussels today that the commission will announce a fiscal stimulus plan next week. The plan will be based on member states taking measures suited to their own economic situation. I like the approach the EU is taking to the crisis, as they will design the stimulus to try and meet the differing needs by each country. According to the EC president, "Everyone is suffering from the crisis and everyone needs treatment, but not everyone needs the same pill."

According to Barclay's Capital, the euro will strengthen 16 percent against the dollar in the next 12 months as Chinese demand drives up prices for oil, reducing the US currencies attractiveness. Two-thirds of the euro's 22 percent slide since the July peak of $1.6038 can be accounted for by plunging oil prices, Barclays said. China is the second largest oil consumer after the US, and "Contrary to current received wisdom, oil prices are much more important for the euro-dollar cross than either the stock market or interest rate differential right now," wrote London-based David Woo, global head of currency strategy at Barclay's. Declining oil prices have helped the greenback by narrowing the US current account deficit, reducing the US's need for overseas funding, Woo said. He forecasts the euro will trade in a range around $1.24 in the next three months, but then rally to $1.45 over the next year as accelerating growth in China helps oil prices retrace their recent fall.

I agree with Barclay's analysis of global commodity prices. China and the rest of Asia will continue to be the world's growth engine, and demand for commodities will increase. The stimulus packages which are being pushed will put additional upward pressure on raw material prices. The commodity rally will not only help the Euro, but will help push up prices of the Norwegian krone, Australian dollar, and Brazilian real.

Switzerland's central bank surprised the market yesterday, dropping its benchmark interest rate by 100 basis points. The Swiss National Bank reduced its target for the three month Libor to 1 percent and promised a 'generous and flexible' supply of Swiss Francs. It's the third unscheduled move by the SNB since the beginning of October. I would expect the SNB to keep rates on hold at their meeting next month given the extent of yesterday's move. The Swiss Franc fell as the dollar strengthened yesterday, but rallied overnight and is now trading close to where it was prior to the SNB move.

In other interest rate news, the Bank of Japan kept its benchmark rate at .3 percent today and said it will consider pumping more money into the financial system to prop up an economy that fell into recession last quarter. Japanese banks are in a much better financial position that banks in the Eurozone or the US, and the Japanese consumers are flush with cash. Japan went through a long deflationary period, and consumers there are less leveraged than here in the US. The stronger position of Japanese banks, and the more solid consumer base will enable the Japanese economy to weather the global slowdown much better than most other economies. The yen will retain its attractiveness as the world faces a long, long recession.

Technical analysts predict the yen may rally to 92.50 in the short term, and could move above the 13 year high of 90.93 which it hit on October 24. According to the analysts, the so-called support level is near the bottom line of a trend channel that tracks the dollar's decline from a two week high of 100.55 yen on Nov. 4. The US currency is poised to extend a 3.5% loss this month as it failed to rise above the 20 day moving average and the down trend is still very clear.

The Australian dollar approached a five year low against the dollar in late US trading and the New Zealand dollar traded near a six year low as investors moved out of the carry trades after the negative US data yesterday. But the Australian dollar bounced back overnight as the Reserve Bank of Australia announced it had bought a record 3.15 billion Australian dollars in October. The RBA continued to purchase its own currency this morning, "providing liquidity as on previous occasions," said a spokesman for the Sydney-based central bank. The Australian dollar has posted a record monthly drop in October and the RBA has been purchasing the AUD$ in an attempt to slow the drop. Commodity prices continue to fall, dragging down the exchange rates of commodity exporting countries. Falling interest rates have also put pressure on the higher yielding currencies of NZD and AUD.

Iceland finally got the long promised bailout from the IMF and four Nordic countries yesterday. The IMF and four Nordic countries gave Iceland a $4.6 billion bailout. The Icelandic government will also borrow about $6.3 billion from the UK, Germany, and the Netherlands to cover foreign deposit guarantees at failed lenders. While the rescue was desperately needed, it will heap almost $11 billion of debt on the shoulders of the islands population of just 320,000. "This is an extraordinary scale of problem related to the size of the economy," IMF Mission Chief to Iceland Poul Tomsen told reporters. "Iceland is in an unprecedented situation." GDP in Iceland is predicted to shrink about 10 percent next year, the IMF says. The island had the fifth-highest per capita income in the world in 2007, but the collapse of their financial system has caused the Icelandic krona to lose two thirds of its value this year. The rescue may start to add some liquidity back into the banking system, but the massive amount of debt will likely keep the Icelandic economy from rebounding for a number of years.

Currencies today 11/21/08: A$ .6212, kiwi .5272, C$ .7817, euro 1.258, sterling 1.4982, Swiss .8194, ISK (No Quote), rand 10.46, krone 7.0831, SEK 7.2031, forint 211.78, zloty 3.046, koruna 20.405, yen 94.87, baht 35.22, sing 1.5304, HKD 7.7513, INR 50.02, China 6.8311, pesos 13.8031, BRL 2.457, dollar index 87.56, Oil $50.38, Silver $9.17, and Gold... $756.88

That's it for today... Big day here on the desk as we are all excited about our Christmas party tonight. Yes, it is a bit early for a Xmas party, but I'm not one to complain about free food and drinks!! And the party is being held at a bowling alley, which is right up our alley (pun intended) as we are a fairly competitive group. I actually took a bowling class in college, but I haven't bowled in a few years, so I hope I can recall some of what I learned back then. Hope everyone has a Fantastic Friday and a Wonderful Weekend!!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 11-21-2008 10:31 AM by Chuck Butler