Downgrade rumors hit France...
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In This Issue.

* Downgrade focus shifts back to Europe...

* BOE keeps rates unchanged & cuts growth forecast...

* China lets Renminbi trade below 6.40...

* Crude oil jumps 4.5%...

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

Downgrade rumors hit France...

Good day. Record levels of volatility continued in the markets yesterday with just about all asset classes gyrating like teenagers on the dance floor at prom. The equity markets in the US faced another day of triple digit swings and the Dow closed down over 500 points. Gold climbed $70 to trade above $1810 before dropping back into the 17 handle. But interestingly enough, the currency markets were fairly calm. I noticed this morning that over the past 10 trading days the dollar index has remained within a 2.5% range. Now there have certainly been some currencies which have been more volatile than the dollar index, but given the tumultuous markets, the currencies have been relatively stable.

Chuck was watching the markets from the floor of the San Francisco Money Show and sent me this note late last night:

Well. another day of reeling for the stock jockeys. but hey, their pain is being felt in other assets too. I sat here in San Francisco and watched Gold continue to climb, finally going over $1,800. and then once again, late in the day, and probably in the afterhours market, as I kind of lost track of time, being on the West Coast, Gold gave up $30. What? Isn't that twice now this week that this has happened? Why aren't Gold investors flooding the CFTC's phone lines asking them for an explanation as to why or how this happened, not once, but twice in the same week..

I gave my presentation on the Change of Currency Regime on Wednesday. I think a scared a lot of people. but, I'm just presenting the facts, and adding one and one to get to the end story. I did have someone ask me about the euro, even though I didn't mention the euro once during the presentation. I told him and the audience that the euro was winning the ugly sister contest. Since the euro is the offset currency to the dollar, and is still more than 1/3 rd of a cent stronger than the dollar, obviously, investors feel that the dollar is uglier. interesting, eh?

And then there was this survey that the Washington Post did, and nearly three-quarters of Americans doubt Washington can repair the economy. But, at the same time, people are all-in on the thought that the Fed can! I could spend all day on that survey. shoot holes in it. but, I think that most long time readers will know what I see wrong with that poll. And with that, I'm going to bed.

Chris again. Chuck has just two more days on the road and then he will fly back home and grace us with his return to the trading desk. We are excited to get him back, and I'm sure he is looking forward to getting back in the saddle.

Attention shifted back across the Atlantic as rumors swirled that ratings agencies would strip France of their AAA ranking. French officials and all three ratings agencies denied the rumors, and Fitch, S&P, and Moodys all affirmed France's current AAA credit rating.

I'm not a big conspiracy guy, but these rumors certainly smell a bit fishy. Investors are on edge and the volatility in the markets makes them vulnerable to a well placed rumor. It only takes a bond trader who is short sovereign debt to post a whisper on a message board or begin a chain of 'telephone tag' among other traders. Suddenly yields on the debt begin to climb and the rumor gets legs. The next thing you know the Credit Default Swap spreads widen as bond traders become convinced a ratings announcement is imminent. By the end of the day the trader who started it all cashes out on his short position and the President of France and all three ratings agencies are forced to make statements.

Not saying that this is what happened here, but it is certainly a plausible possibility. Traders are constantly trying to predict the next 'big event', and a quick scan of the AAA rated countries would put focus on France which has a debt to GDP ratio of 82%, among the highest of all top rated countries.

I think investors should be more worried about the large European banks instead of focusing on the next country to be downgraded. Both French and German banks have large exposures to the sovereign debt of Greece, Portugal, Spain and Italy. While the ECB has been supporting the debt markets with direct buying, any future bailout will certainly involve another 'restructuring' of this debt which will mean further losses to the European banks.

As Chuck has said in last night's note, the Euro is currently in second place in the ugliest currency contest, so it has been able to maintain its value vs. the US$. While I continue to believe the euro will hold its value, I just don't see it appreciating sharply as it remains incredibly vulnerable to continued problems throughout Europe.

The IMF and EU have prepared a review of Portugal's first rescue package which should be released today or tomorrow. Officials will then decide whether or not to give Portugal the second tranche of its bailout. As I said earlier, the debt crisis in Europe is going to continue to force its way into the news for years to come.

The Bank of England releases what one analyst called a 'relentlessly bleak outlook' for Britain's prospects as it left rates unchanged. The BOE downgraded its growth forecast for the next three years, cut its longer term inflation projections, and warned that the risks remain 'on the downside'. The BOE now believes inflation will peak at 5% in the next few months before falling back at the end of the year and dropping below the 2% target in 2013. So much for the Pound Sterling becoming a safe haven currency for euro investors!

The pound weakened against the euro on the face of the bleak economic outlook and worst British riots in 30 years. Chancellor of the Exchequer George Osborne will be addressing parliament today to defend the steepest government spending cuts since WWII.

The Swiss franc weakened a bit yesterday after a Swiss central bank Vice President voiced the possibility of pegging the franc to the euro. "Any temporary measures to influence the exchange rate are permissible under our mandate as long as these are consistent with long-term price stability," SNB VP Thomas Jordan said in an interview. Swiss exporters are feeling the pain of the high values of the Swiss franc vs. the euro, as the vast majority of Swiss trade is completed with European companies and consumers.

Perhaps the SNB would be wiser to attach the anchor of the US$ on to the high flying Swiss franc. It has certainly seemed to work for the Chinese, and instead of keeping the Swiss stable with the euro, a peg to the dollar would probably cause an adjustment lower for the value of the franc.

In an interesting twist, China is just starting to move in the opposite direction, relaxing their peg and allowing the Renminbi to appreciate vs. the US$. China is borrowing a page from Singapore's playbook and will apparently use their currency value as another tool to combat inflation. China's Renminbi rose .37%, the largest gain in nine months, and closed below 6.40 for the first time since the peg to the US$ was relaxed.

The recent moves higher by the Renminbi are welcomed by the IMF who said last month that a stronger Chinese currency would help stabilize the global economy. A higher currency value will also assist the government in its effort to tame inflation and rebalance the nation's growth toward domestic demand and away from exports. As I reported yesterday, China's trade surplus reached a record level, but imports actually grew at a faster pace than exports. The burgeoning middle class in China will benefit global growth, and hopefully Chinese officials can continue to encourage domestic spending.

Speaking of trade deficits, data will be released today which is predicted to show June's US trade deficit narrowed to 48 billion from just over 50 billion in the previous month. The poor consumer spending data which we have seen over the past few months should seem to support this view.

We will also see the weekly jobs numbers this morning, with jobless claims predicted to stay

above 400k for another month. Continuing claims probably declined, as more unemployed individuals fell off the roles.

The price of crude oil jumped 4.5% yesterday as a report on US inventories showed a surprise decline. Oil had been falling due to the uncertainty of the global economic recovery, trading as low as $79.73 per barrel. Prices of oil were down over 9% for the year, and 13% for the month, but inventory data released yesterday reversed the trend.

The Energy Information Administration (boy that certainly sounds like a shadow group, and a good candidate for govt. cuts!) reported its estimate of domestic crude inventories dropped by 5.2 million barrels, matching a trade group's forecast released late Tuesday. Earlier Wednesday the International Energy Agency trimmed its 2011 forecast for global oil demand by 60,000 barrels a day, citing slower economic growth.

The oil based economies of Norway, Canada, and to a lesser extent the UK and Brazil all should benefit from this latest rise in crude prices.

The Norwegian krone could use some good news after the Norges bank delayed a predicted rate increase. Officials of Norway's central bank left rates unchanged for a second consecutive meeting as worries over the global economy and the recent drop in oil prices calmed fears of rising inflation. I was in agreement with a majority of economists and fully expected rates to rise, and the currency was sold after the announcement.

Even without a rate increase, Norway's krone remains one of the fave's of the desk and I think this latest move lower should be seen as an excellent opportunity for investors to purchase more krone.

To recap. France is the latest country to come into the cross-hairs of the rating agency, or are they? All 3 ratings agencies denied they are going to strip France of their AAA rating. The BOE kept rates unchanged, and released a bleak outlook for the UK economy. Switzerland could look to peg the franc to the euro, and China is allowing their currency to adjust away from the peg to the US$. Crude oil jumped 4.5% as inventories showed a decline, and Norway surprised the markets with a 'non-move' for interest rates.

Currencies today 8/11/11 American Style: A$ $1.0215, kiwi .8174, C$ $1.0062, euro 1.4188, sterling 1.6162, Swiss $1.3481. European Style: rand 7.2622, krone 5.5261, SEK 6.5577, forint 194.56, zloty 2.9494, koruna 17.005, RUB 29.5735, yen 76.62, sing 1.2137, HKD 7.7996, INR 45.3763, China 6.3937, pesos 12.4060, BRL 1.625, dollar index 74.66, Oil $82.82, 10-year 2.20%, Silver $39.2563, and Gold $1,780.65

That's it for today. The desk enjoyed a happy hour arranged by Jennifer last night and apparently it went well into the night. Unfortunately I wasn't able to join them as I went right from a late meeting to my daughter's first soccer game. Just one more day of Pfennig writing for me, as Chuck will be back in the saddle on Monday! Hope everyone has a Tub Thumping Thursday. Thanks for reading the Pfennig!!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 08-11-2011 10:34 AM by Chuck Butler