Dollar continues to slip as time ticks away.
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In This Issue.

* US debt situation doesn't improve...

* BRL, NZD, AUD, & INR benefit from higher rates...

* US data don't bode well for our economy...

* Greek debt gets another downgrade...

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

Dollar continues to slip as time ticks away.

Good day. It's Crunch Time. We are less than a week away from the debt ceiling and none of the plans seem to be getting much support in congress right now. As I reported yesterday, both parties have come up with plans to increase the debt ceiling, and many thought a compromise was imminent, but overnight the rhetoric has heated up from both sides. Chuck pointed out late last week that political positioning has now taken over. President Obama has promised to veto Boehner's debt plan, and the House certainly doesn't want to let the Democrats kick the debt problems past the 2012 elections.

I had more than a few readers question my statement about their being a 'silver lining' in all of this, and even I am now wondering if we will see any 'real' cuts in spending with all of the politics. The CBO has stated that 150 billion of Rep. Boehner's cuts are not really cuts at all. And this is after many in Boehner's party had already denounced Sen Reid's bill because billions of cuts were going to come from the end of the wars which no one planned to spend money on anyway. So both sides seem to be using gimmicks instead of making real cuts to spending. Rep. Boehner quickly announced he would look to replace the gimmicks with other spending cuts to get to his original proposed cuts.

I continue to believe some sort of compromise will be reached. A story on Reuters this morning says the Reid and Boehner bills are actually quite similar. The bond market is sure acting like a deal will be reached, as yields on the 10 year US bonds have fallen back down to just 2.95% this morning (a big move from yesterday's 3.02%!

And hopefully after all of the dust settles and the rhetoric dies down, we will see some actual cuts to the runaway spending. We have all heard about the financial Armageddon which will occur if we don't raise the debt ceiling, but my co-worker Aaron Stevenson sent me an article on Monday which pointed out that the US Treasury has enough cash to pay the bills for a couple of weeks after next Tuesday's deadline. August 2nd is just the day we get the credit card taken away, but we still have some cash in the wallet. So we won't be immediately thrown into a default on August 3rd. But either way, the inability of our elected officials to reach a compromise has been a blow to our credibility overseas.

Reserve Bank of Australia Governor Glenn Stevens blasted both the US and Europe over the way they have dealt with their sovereign debt issues. Stevens said "in both the US and European cases, the process of allowing things to go right to the brink of a very disruptive event before an agreement is reached on the way forward has been a source of great uncertainty and anxiety around the world." Well said Governor Stevens, well said.

Even if an agreement is reached, many now expect the US will lose its AAA rating. A compromise will likely not have the spending cuts needed to put the US budget back on a positive trajectory, and any deal will likely be short term, causing another round of political negotiations next year (an election year). S&P placed the US on 'creditwatch' back on July 14, and said there is a 50 percent chance the rating would be cut in the next 90 days even if an agreement is reached.

And what happens to the dollar after this is past us? While the knee jerk reaction to any agreement will almost certainly be an immediate dollar rally, any gains could quickly be reversed. A report released by BNP yesterday predicted a successful resolution of US debt negotiations would leave the dollar under pressure because it makes it more likely that we will see a QEIII. "Even if a credible deal is struck that eliminates the debt default risk and gets the support of the ratings agencies, any support for the dollar could prove transitory," the London team of BNP currency analysts wrote in a research report today. The "market may soon after conclude that the implied fiscal headwinds in 2012 either raises the risk of the Fed enacting QE3 or at a minimum imply a public commitment to a longer period of near zero rates," they wrote.

With US rates expected to remain low, the higher yielding currencies of AUD, NZD, BRL, and INR have been soaring in value. Brazil's real gained on the back of the world's second highest inflation adjusted interest rates. Investors have been attracted to Brazil's emerging economic story for a while now, and some of the globes highest interest rates have made this a very attractive investment. Brazil continues to raise their rates in order to combat inflation, and their currency has been pushing higher even as the government attempts to limit the flow of 'hot' money into their country.

I touched on India's surprise interest rate increase yesterday, and the rupee continued to move higher throughout overnight trading. After the increase the Reserve Bank of India signaled it's prepared to accept a slower economy in order to keep inflation at bay. The bank said in a statement that stronger action may be required to damp demand, a pretty clear sign that more rate increases are in the works.

I mistakenly reported that we would have to wait until next week to see the big CPI data in Australia, but the report for the 2nd quarter was actually released this morning. Chuck pointed out my error in a note he sent me late last night, so here's Chuck:

Ok. a full day of "conference work" has left me tired. I do get tired easily, so it's not as if I was asked to go on a 5 mile hike up Grouse Mountain! Well. I guess the people that kept calling for a a rate cut in Australia will have to take a second look. for Australian Q2 CPI data was released last night and Headline inflation increased +0.9% versus consensus of 0.7% quarter on quarter. Annual CPI grew at +3.6% versus consensus of 3.4%

I don't see where a rate cut makes any sense here, and so. my call for one more rate hike before the year runs out, sure seems to be the call to order now doesn't it? I don't like to brag when I'm right, and I'm not right yet, not unitl the Reserve Bank of Australia (RBA) does hike rates. but at least I can sneer at those that were calling for a rate cut, and say: neener, neener, neener!

Did you see that Consumer Confidence increased this month? WHAT? Apparently, those that were surveyed hadn't watched TV lately, to see our President warn of Armageddon.. As I've told at least 2 dozen people here. We are not going to default. It's the honor of the country! This is all theatrical politics. so, maybe those surveyed here, aren't playing the President's game..

And new Home Sales didn't go very well last month, but don't let that get in the way of a "feel good story"! So. until we get the final decision on the debt ceiling deadlock, the markets will be held hostage. but again, we are not going to default. now. I think that comes much later.

That is. if we don't change our spending habits!

Chris again. Thanks to Chuck for setting things straight this morning, and for focusing attention back on the economic data being released in the US this week. I have been so caught up in all of the debt ceiling talk that I have failed to share any of the US data. As Chuck pointed out, yesterday's data was a bit of a mixed bag with disappointing New Home Sales, but Consumer Confidence actually increasing.

Today we get Durable Goods Orders along with the Fed's Beige Book which attempts to take the 'temperature' of the US economy. The Durable Goods number is expected to be .3%, and lately it seems like even this number is a bit too optimistic. The Beige Book is the 'view from the Fed' so it will likely show the US is still expanding, but not at a rate which would allow the Fed to begin taking away some of the liquidity it has pumped into the markets.

Tomorrow we will get the weekly jobs numbers along with Pending home sales. Friday we will get the 2nd quarter GDP numbers along with Personal Consumption and the U of Michigan Confidence numbers. All of this data will certainly be overshadowed by the debt negotiations, but I will try to remember to bring you the data since it should give us a better indication of just how good or bad the US economy is doing.

One thing the US debt ceiling talks have done is shift the attention away from Europe's struggles. I have been writing the Pfennig for 3 days now and have yet to talk about the European situation. Investors seem to be accepting the plan proposed for Greek bondholders, and Spain was able to sell 2.89 Billion euros of treasury bills yesterday. Rates were slightly higher than they targeted, but it was good to see a successful auction. Moody's continues to weigh in on the European debt crisis as they downgraded Greece's credit rating three steps. In their announcement, Moody's said the EU's rescue for Greece will cause a substantial loss for investors, and amount to a default. But an agreement reached prior to the adoption of the EU rescue kept the default provision of the Credit Default Swaps written by US banks and insurance companies from kicking in.

The losses which are being thrust upon holders of Greek debt is a warning to those who hold Portuguese or Irish bonds. The Greek rescue template will certainly be used if / when Ireland or Portugal need an additional bailout. But the bright side of this is that investors seem to be accepting of the terms, and the risk of a Eurozone breakup has certainly fallen. Nuriel Roubini, the economist who predicted the global financial crisis, said the risk of a breakup in the Euro area is much smaller than a year ago. The risk of deflation in advanced economies has also fallen according to Roubini.

To recap. US debt crisis continues, and both sides seem to be digging in their heels. RBA Governor Stevens has strong words for US and Europe. The high yielders of AUD, NZD, BRL, and INR are the big winners in the currency markets. Data here in the US don't point to an expanding economy. And the chances of a Eurozone breakup have declined according to Roubini.

Currencies today 7/27/11. American Style: A$ $1.1045, kiwi .87465, C$ $1.0613, euro 1.4468, sterling 1.6388, Swiss $1.2496. European Style: rand 6.6496, krone 5.3611, SEK 6.2634, forint 185.15, zloty 2.7702, koruna 16.7830, RUB 27.45, yen 77.80, sing 1.2019, HKD 7.7907, INR 44.05, China 6.4429, pesos 11.6215, BRL 1.5391, dollar index 73.644, Oil $98.84, 10-year 2.95%, Silver $40.80, and Gold $1,612.75

That's it for today. Apparently this will be the second Pfennig of the day, as our servers apparently decided to send out yesterday's Pfennig earlier this morning. I guess it was a hint that I need to get going on getting this out the door! Took my son shopping last night for new football gear. Two-a-day practices start next week, and with triple digit temps I certainly don't envy him. Thanks for reading the Pfennig, and everyone have a Wonderful Wednesday!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 07-27-2011 10:02 AM by Chuck Butler
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