Belt tightening by US consumers cuts the dollar rally short.
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In This Issue.

* US$ falls due to wary US consumers...

* SNB tries to turn the Swiss franc...

* Worries over US recovery hurt CAD and MXN...

* Australia books a lower trade surplus...

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

Belt tightening by US consumers cuts the dollar rally short.

Good day. Welcome to hump day. My tenure as your pfill in Pfennig writer is half over this morning, as Chuck will be back on the desk in 1 ½ weeks. I will certainly welcome his return! While I enjoy writing the Pfennig, we are in an important part of our system testing and the 14 hour days are beginning to wear on me. But you don't want to hear about that, so I will get right to the currency markets.

The debt deal was signed by President Obama so the political side show of the debt ceiling debate is finally over. As readers know, I am actually happy our skyrocketing debt and ballooning deficits grabbed headlines for a while. And I was glad to see congress has agreed on 'automatic' spending cuts if they can't reach an agreement in the future. This is truly the only way we are going to see spending in DC reduced, very few elected officials have the courage to go back to their constituents and tell them they are going to have to accept less from the government. Automatic across the board spending cuts may not be the fairest way to start to balance our budget, but it is definitely the easiest. Now they need to begin working on the revenue side with some tax reform (and yes, that will probably mean we are going to have to pay more!).

As I hit the send button yesterday morning, the dollar was continuing to tick higher following the large gains it had booked in European and Asian trading. But the euphoria over a debt deal in the US was short lived. A report released early yesterday had investors moving back out of the dollar. The report showed consumer spending had unexpectedly dropped in June for the first time in almost two years. Purchases by US consumers were .2% lower in June compared to the previous month when they increased .1%. Personal Income was also lower than expected, increasing just .1% compared to May's revised .2% increase. A lack of jobs, and worries about rising prices has consumers tightening their belts. The frugal trend certainly makes sense, and is exactly what the US consumers should be doing, but it isn't good news for US recovery. Consumer spending accounts for 70 percent of the US economy, and a large slice of the global economy. So wary US consumers caused a move away from the 'risk' assets.

But what safe havens are left? The debt debate has shaken many investors opinion of the US dollar and the continued European sovereign debt crisis has made the euro less attractive. Recently investors have looked to the Swiss franc and Japanese yen as havens, and both currencies rallied as the trading day ticked by. As I left for home last night, the Swiss franc had gained an impressive 2.81% vs. the US$ and had booked the largest one day gain vs. a basket nine developed nation currencies in more than 36 years. The Japanese yen also moved higher, but the Bank of Japan made noise like they would be intervening, and helped stem the yen's rise. Japanese Prime Minister Naoto Kan, Bank of Japan Governor Masaaki Shirakawa, and other officials will hold a meeting today to discuss the yen-dollar exchange according to a Japanese newspaper. We could see the BOJ pushing yen into the markets in a further attempt to push their currency lower. The BOJ will be holding their policy meeting Aug 4-5, so we will probably see additional 'jawbone' intervention through the end of the week.

Taking a cue from the BOJ, the Swiss National Bank decided it was time to act and act decisively. The SNB unexpectedly cut interest rates and flooded the markets with francs in an effort to stem the currency's surge. The central bank also hit the airwaves, suggesting it would take additional measures to weaken the currency if necessary. The combination of a cut in interest rates, additional liquidity, and jawboning by the central bank had the desired effect and the Swiss franc reversed course, moving down vs. the US$ for the first time in 5 days. But as we have told readers in the past, a single central bank cannot win a war against the massive global currency markets. Without the help of others, the efforts by the SNB will be futile, no matter how many Swiss francs they sell into the markets. And currency traders in NY are taking the Swiss franc higher again as they begin their days. Right now almost half of the Swiss franc's drop caused by the SNB intervention has been reversed. It looks like 'game on' for the SNB and the currency traders! While the SNB may win a battle, the war will be won by the currency traders.

As I warned investors yesterday, the Swiss franc was moving too far too fast, and booking some profits is probably wise. While the Swiss should remain as one of your 'base' holdings in a well diversified currency portfolio, a reallocation is prudent, taking some of your profits off the table at these high levels. The SNB has been tenacious in the past, and will likely continue to try and stem any further gains in the near term.

Staying in Europe, the pound sterling fell to the lowest level in almost two weeks vs. the US$ after a gauge of UK building activity slipped. Another report released yesterday showed manufacturing unexpectedly shrank the most in more than two years, adding to worries over the UK recovery. But another report released this morning showed UK services moved opposite the manufacturing numbers, and unexpectedly rose. This helped stall the pound's slide. Band of England policy makers will be meeting tomorrow, and are expected to keep their key interest rate at a record low. We may also see some suggestions of a further expansion of quantitative easing, as the UK economy continues to sputter. Fundamentals of the pound sterling are just not supportive of the currency, and without the buying form those worried about the Euro zone problems the pound would be much weaker.

Concern over the US economic recovery sent both the Mexican peso and Canadian dollar lower. US consumers are just as important to the economies of Mexico and Canada as they are to the US. The fall in US consumer spending sent shock waves both north and south of our borders. The Canadian dollar dropped to a two week low vs. the dollar and sent bond yields lower in Canada. Investors are shifting out of North American equities and seeking the relative safety of bonds, sending prices higher and yields lower. While Canada has strengthened their trading ties with China, they are still dependent on the US for a majority of their trade, so a weak US economy is eventually going to be reflected in the value of the Canadian dollar. Mexico's peso also fell vs. the US$, paring some of the gains it had made through the first half of 2011. The Mexican pesos is the third best performing Latin American currency vs. the US$, rising 6.8% vs. the US$.

Brazil is the best performing Latin American currency this year and is 11.43% higher vs. the US$ this year. The most recent attempts by Brazilian officials to stem the currency's rise seem to be working as the currency has stalled out in trading over the past week. Brazilian central bank President Alexandre Tombini has signaled that rates will be held stable for the remainder of 2011 as industrial output has fallen. Industrial production in Brazil fell more than economists expected in June, matching the global manufacturing slowdown which I reported on yesterday.

Another of the high flying currencies during 2011, the Australian dollar, fell to its lowest level in two weeks against the dollar. A report released yesterday in Sydney showed a lower than forecast trade surplus in June. Australia's trade surplus narrowed as imports surged to the highest level in more than two years. Exports exceeded imports by A$2.05 billion compared with a A$2.7 billion surplus in May. Exports held steady on the month after rising in the previous three months. While the numbers disappointed the markets, Australia continues to undergo a mining-investment boom to meet demand from India and China. Australia is perfectly positioned to take advantage of the increase in the standard of living in both of these populous countries. This is what will keep the value of the Aussie dollar well bid, in spite of the troubles in Europe and the US.

To recap. The dollar rally caused by the debt agreement was short lived, as consumer spending in the US showed an unexpected drop. The Swiss franc zoomed higher yesterday, but its rise was abruptly halted by the SNB who cut rates and intervened by selling francs. The pound sterling fell as UK building activity slowed. Concern over the US economic recovery sent both the Canadian dollar and Mexican pesos lower. And finally, the Aussie trade surplus shrank during June, but a surplus is still a surplus!

Currencies today 8/03/11 American Style: A$ $1.0767, kiwi .8657, C$ $1.0428, euro 1.4306, sterling 1.639, Swiss $1.2924. European Style: rand 6.7591, krone 5.3734, SEK 6.3522, forint 190.55, zloty 2.8191, koruna 16.98, RUB 27.826, yen 77.07, sing 1.2073, HKD 7.7972, INR 44.32, China 6.4342, pesos 11.8269, BRL 1.5673, dollar index 74.10, Oil $93.18, 10-year 2.61%, Silver $40.885, and Gold $1,666.35

That's it for today. A bit shorter than usual this morning, but as I suggested in the first paragraph I am dragging a bit. My wife and kids had a great day floating the Huzzah river yesterday in spite of the triple digit temps. They said the water was crystal clear and fairly cold, so they were able to beat the heat. Tonight my wife and I are heading to dinner with close friends so I am looking forward to the end of the work day. Cardinals pulled out a win last night, with the help of a 3 run home run by our pitcher! Hopefully this 11th inning win will start a new streak. Hope everyone has a Wonderful Wednesday, and thanks for reading the Pfennig.

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 08-03-2011 2:47 PM by Chuck Butler