Frightened investors move back into US treasuries.....
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In This Issue..

* Jobs data skewed by 'seasonal adjustments'...    
* BOE surprises the market...          
* Oil falls below $60...                            
* China's reserves continue to grow...                                                           

And Now... Today's Pfennig!

Frightened investors move back into US treasuries.....

Good day...Chuck has a bevy of doctor's appointments today, so he decided to let me take over the Pfennig.  Unfortunately it will go out a little later than usual, as I always struggle to get all of my thoughts together so early in the morning.  Its not that I come in late (I was here two hours before everyone else) but it just takes me much longer than Chuck to get it all on paper.  But enough of the excuses, I've got to get writing.

Weekly jobless claims released in the US yesterday morning fell below 600k for the first time since January but the continuing claims continue to rise, hitting another record.  The slight improvement in the weekly numbers was distorted by the automotive sector.  Car companies typically shut down plants in early July in order to change over to the new model year.  Bankruptcy forced many of these plants to shut down much earlier than normal, and some temporarily started up production again during the past few weeks.

Chuck would have a field day with the jobless claims, as the government economists were hard at work 'massaging' the numbers to give everyone a more 'clear' picture of the data (why can't they just report the actual number of people filing for unemployment?).  As Chuck has pointed out, the Labor Department adjusts the figures using seasonal and demographic trends, creating 'ghost jobs'.  Since automobile plants typically shut down in the first weeks of July, the labor department expected a large increase in claims during this time.  In order to offset these 'seasonal factors', the brain trust at the Labor Department added back a number of jobs in order to balance out the expected temporary layoffs in the auto sector.  You would think the Labor Department would realize that most of these automobile workers were already idled, and therefore keep the adjustments to a minimum.  But that would be too logical, so they just went ahead and 'seasonally adjusted' the claims as if this was a typical July for the auto sector. 

The continuing claims illustrate a much clearer picture of the US job market, with unemployment spiking up to 9.5% in the US.  The news from the retail sector was also gloomy, as the ICSC Chain Store Sales fell another 5.1% YOY during the month of June.  Inventories also continued to shrink for a ninth month in a row in May to just over $400 billion.  This is the lowest level since August of 2007, and raises some longer term inflationary concerns.  Some of you are probably questioning this last statement, so I will explain.

Lower retail sales have forced stores to keep inventories down.  I was in a local Walmart store the other day and noticed the shelves were emptier than what I have seen in the past, items weren't stacked 5 deep and didn't reach toward the ceiling.  US consumers have been buying less and saving more, a very good thing!  But stores have reacted by dropping the amount of inventory they are carrying (again a smart thing for retailers).  Against this backdrop, the US government continues to flood the economy with cash, trying to get consumers to start spending again to jumpstart the economy.  For now, the cash has been hoarded by banks and used by consumers to pay down some of their massive debt.  Eventually the 'all clear' horn will sound, and consumers will start looking to make purchases again, but will find empty shelves.  Inflation will follow, as too much cash will be chasing too few goods. 

But our government has a much shorter term view, and continues to pump money into our economy with no real regard for future inflationary concerns.  And some very smart economists seem to agree with the administration.  Both Nouriel Roubini and Robert Shiller, respected economists, are calling for additional stimulus.  In a radio interview yesterday, Roubini predicted the US recession will last another six months and be followed by a 'shallow' recovery.  On the same radio show, Shiller said the economic crisis would continue despite the $12.8 trillion pledged by the US government and Federal Reserve.

The BOE shook up the markets with a surprise announcement not to increase its quantitative easing program.  The Bank's Monetary Policy Committee put the program designed to pump extra cash into the markets by purchasing its own debt on hold after announcing it would also keep interest rates steady at .5%.  The move was a major surprise to the markets, and sent the price of gilts (the UK's treasury bonds) falling and the price of the Pound Sterling higher.  The BOE was the first of the western central banks to begin the controversial program in which it monetizes its debt; hitting the overdrive button on the printing presses by monetizing its debt.  We've never been a fan of the Quantitative Easing programs, as they are short sighted with total disregard for the future inflationary pressures the exert on the economy.  But several other central banks, desperate for a way to get cash into their economies have followed the BOE's lead.   

The move by the BOE was even more surprising given the fact that the Chancellor has authorized another 25 billion pounds to be added to the program.  Perhaps the Bank's Monetary Policy Committee is finally starting to realize all of the QE which it has done hasn't really had the desired impact.  Much of the extra cash being created by the program is simply being hoarded by banks and is not making its way out into the economy via loans.  Sound familiar?  We have a similar situation occurring here in the US, with banks sitting on a majority of the stimulus monies which they have received.  They have used the funds to shore up their balance sheets, a good thing long term, but not what the central banks intended with the introduction of the QE programs. 

But enough of the economic talk, I need to let you know what happened to the currency markets overnight!!  In spite of the Labor departments attempts to 'adjust' the weekly jobless claims, the economic data released here in the US yesterday was generally poor.  This raised further concerns regarding the global economic recovery, and forced investors back into the US treasury market.  As typical during these periods of uncertainty, the Japanese yen was the best performing currency.  This is due to a general deleveraging as investors purchase yen to pay down debts used to invest into higher yielding assets. 

We have seen this pattern repeat several times over the past year.  As investors start to see some signs of recovery in the global economy, they invest into the higher yielding currencies, and borrow funds at lower rates available in Japan.  But as soon as they begin to question the recovery, they move back out of the higher yielders and pay back these loans in the Japanese yen.  Morgan Stanley believes the recent move by the yen is just the beginning of another big move, predicting a move to 85 yen/dollar.  The foreign exchange strategists at Morgan Stanley predict the yen will continue to rally through the end of the year as doubts about the global recovery intensify.  But their longer term predictions are less enthusiastic, as they feel the yen will weaken throughout 2010.

The commodity currencies took a hit over the past few days as the price of oil and metals continued to fall.  Oil fell below $60 per barrel for the first time in a couple of months.  Concerns over the global recovery, along with some slight calming of tensions in the gulf states have caused the price to drop.  One commodity currency which has been able to hold steady during the recent selloff is the Brazilian real.  A report that car sales in China surged bolstered the outlook for the commodity rich country.  China's passenger-vehicle sales rose 48% in June, pushing China past the US as the world's largest auto market.

Increased automobile demand in China is another sign of their slow move away from an export based emerging market economy to that of a more balanced one.  China's exports tumbled for an eighth month in June, but internal demand helped by the government's stimulus package is offsetting some of the impact of these falling exports.  Imports also fell, but the size of the decrease was the least in eight months.  This is good sign for the future of China, as imports are typically a leading indicator for exports in China. 

China's foreign exchange reserves likely topped $2 trillion for the first time, climbing another $67.8 billion in the second quarter.  The central bank is predicted to release the number sometime today.  The increase in reserves certainly cause concern in the currency markets, as officials in China continue to call for the diversification of these reserves.  According to a story in the Financial Times, China launched its highest profile criticism of the dominant role of the US dollar as a global reserve currency during the last day of the G8 meetings in Italy.  "We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies exchange rates and promote a diversified and rational international reserve currency system," Chinese state Councilor Dai Bingguo was reported to say.  Western leaders tried to play down the remarks, with Gordon Brown stating that he did not remember Mr. Dai making the remarks. 

Separately, Joseph Yam, chief executive of the Hong Kong Monetary Authority, said Hong Kong might consider diversifying more of its $200 billion reserves away from the US dollar.  I would expect China to keep the heat on the Obama administration in order to try and get them to reign in some of their 'quantitative easing' programs.  The Chinese officials continue to be concerned about the future inflationary consequences of these programs.  But at the same time, they have to be very careful about the diversification out of the dollar, as they still hold trillions of dollars and don't want to cause a sudden fall in their value.  The big boss, Frank Trotter, constantly reminds us that China has a much longer term thought process, and has an extreme amount of patience.  I would expect them to continue to slowly diversify their holdings, adding to the long slow decline of the US$.

With that I will move on to the currency roundup.  Sorry to go so long this morning, but I felt like there was a lot of data to get through. 

Currencies today 7/10/09: A$ .7760, kiwi .6263, C$ .8596, euro 1.3902, sterling 1.6198, Swiss .9172, rand 8.196, krone 6.5369, SEK 7.9021, forint 199.10, zloty 3.1440, koruna 18.708, yen 92.76, sing 1.4623, HKD 7.75, INR 48.97, China 6.8327, pesos 13.6408, BRL 2.009, dollar index 80.489, Oil $59.66, 10-year 3.337%, Silver $12.64, and Gold... $909.39

That's it for today... Everyone is limping into the office this morning, as we played a double-header in our kickball league last night.  We ended up splitting the two games, but as my wife continues to tell me, kickball is a game for kids, not middle aged currency traders!!  One of our team had to go to the hospital last night, as he injured his shoulder diving for a catch in the outfield; I hope Joe B's shoulder turns out to be ok!!  St. Louis is getting ready for the All Star weekend, and I saw one of the blimps floating around last night.  My son, Brendan and I are heading downtown to compete in the All Star Charity 5k run which begins at Busch Stadium.  It will be fun to be downtown and around all of the All Star hoopla, even though we don't have a ticket to any of the events.  Hope everyone has a fantastic Friday and a Wonderful Weekend!!

Chris Gaffney, CFA
Vice President
EverBank World Markets
1-800-926-4922
1-314-647-3837





Posted 07-10-2009 9:46 AM by Chuck Butler