Euro moves higher after a positive IFO index and a successful Spanish debt auction...
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In This Issue.

* Euro pushes higher after an upbeat report...

* Spain's debt auction finds a host of buyers...

* Sweden cuts .25%...

* A tax to cap income???

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

Euro moves higher after a positive IFO index and a successful Spanish debt auction...

Good day. Another rainy day here in St. Louis, it feels like we haven't seen the sun in days. A few degrees colder and we would be in the middle of a blizzard. I didn't have to deal with being locked out this morning, so it is starting out as a better day.

The euro sure enjoyed a better night rebounding from close to its annual low vs. the US$. A surprisingly upbeat IFO business climate index combined with a pledge of more funds for the bailout and a positive Spanish auction to send the common currency higher. The IFO Institute's index, based on a survey of 7,000 German business executives, rose to a three month high of 107.2 from 106.6 in November. Economists had expected the index to drop to 106. November's number had surprised on the upside also, so this month's value certainly seems to confirm a trend which indicates Germany's economy may be able to push through all of the credit crisis to remain on a solid growth path.

The euro rose back above $1.30 after dipping into the $1.29 handle a couple of times last night. Spain sold 5.64 billion euros of 3 and 6 month bills compared with a target of 4.5 billion euros. This was a very successful auction, albeit of short term paper. The average yield on the Spanish debt was just 1.735% compared with 5.110% when the bills were issued in the last week of November. The six month yields were also lower at 2.435% compared with 5.227% in November.

The EU helped to insure a successful auction by boosting their anti-crisis efforts, pledging additional 150 billion euros to the IMF. Four countries not using the common currency also pledged to add to the IMF, but the UK pushed themselves further away from the EU by refusing to commit to a specific funding amount. UK officials will define their contribution in early 2012. It almost seems as if the UK is wanting to see the euro problems continue, and their refusal to commit funds kept the EU from reaching their target of 200 billion euros of additional capital. The UK is certainly making it difficult for the EU, and it will be interesting to see if there are any long term repercussions if/when the Euro zone begins to recover. I've already see that the French central bank president is suggesting the ratings agencies should focus on the UK instead of spending so much time in central Europe. Apparently he was upset with Fitch after they lowered France's credit outlook.

The pound sterling weakened against the dollar after a report in the UK showed home sellers cut asking prices for a second consecutive month. Even though the UK would like to think they can stay out of the Euro-zone fray, they are dependent on the European mainland for a majority of their trade, and all of their recent posturing isn't going to endear them to their neighbors to the east.

As I mentioned yesterday, ECB President Draghi has thus far refused to increase the bank's direct purchases of sovereign debt. Draghi and the ECB has instead focused on keeping European banks flush with liquidity. We will see just how much liquidity the banks need tomorrow when the ECB opens up a 3 year lending window. Unlimited cash will be offered up to European banks at the benchmark rate of 1% for three year terms. The ECB has also loosened collateral requirements for the loans which should encourage more borrowing by the banks. The only question is whether these banks, which already have been burned by the sovereign debt crisis, will decide to invest some of these new funds back into the debt market. Readers will recall the Fed opened up the vault doors to US banks during the mortgage crisis, but these banks used the additional funds to shore up their balance sheets instead of going out and lending or purchasing mortgage debt. While the banks will look healthier, I'm not so sure the additional liquidity will be able to do much to keep yields down in the sovereign debt markets.

Sweden's Riksbank cut rates as expected. The .25% cut from 2% to 1.75% was the first cut since 2009, but as I said yesterday, the move was predicted by a majority of economists. Sweden's krona rallied after the cut as investors looked at the rate cut as a positive indication of future growth. There was also many who had thought the cut would be even larger, so the .25% move was seen as a reason to move back into krona investments.

The commodity markets have been gyrating like a young Elvis' hips, with oil swinging higher in the past two days. US crude stockpiles declined for a second week, and there is speculation that the Gulf Cooperation Council which meets in Saudi Arabia this week will reduce supplies from Iran. Sanctions against Iranian oil are being discussed as a response to Iran's nuclear program, and a cut in supply from OPECS second largest producer would definitely impact the price. Oil is inching back up toward $100 per barrel after falling down to just over $92.50 last week.

The move higher has helped boost the Canadian dollar and Norwegian krone, both big oil exporting nations. But another big commodity producer, Brazil, saw their currency fall for the first time in three days after worries over the impact of the death of Kim Jong Il caused investors to exit 'risk trades'. The Brazilian central bank has done an 'about face' recently regarding the value of the real. Chuck warned that the policy makers in Brazil would rue the day they decided to depreciate their currency, and recent actions suggest they have seen enough. The central bank held an auction yesterday to sell dollars, buying reals. These were repos, so the dollars will be bought back as soon as one month from now, but the immediate impact is to strengthen the real. This is a 180 degree turn from the back in September when policy makers took action to limit the appreciation of the real. They should have listened to Chuck's warnings!!

The data cupboard was pretty bare yesterday, and housing starts and permits for the month of November will be the only releases today. Since this is a bit later than usual, I am able to tell you the housing starts for the month of November came in slightly higher than expected at 685k, a large 9.3% positive move from October. Building permits were also higher at 681k, a 5.7% gain from October. This is definitely a step in the right direction, and an indication that the US may just be able to muddle through at a stepped up pace. Tomorrow we will get an indication of how the existing homes are selling.

Then there was this. Frank sent me his thoughts on an op-ed piece which ran in the NY Times over the weekend. It definitely generated some talk on the desk this morning, and Frank has a good take on it. So here's Frank:

The phodder one finds on editorial pages both left and right are often a flight of fancy. Harebrained proposals for this or that which even on a cursory reading suggest little analysis or attention to unintended consequences. The good news is that nearly all are ignored and relegated to the ash bin. But these articles can be an indicator of political mood and even if not adopted outright we should view them at least as the smoke indicating a fire out of sight.

Here's one that really caught my attention - In a New York Times op-ed Sunday Ian Ayres and Aaron S. Edlin propose - and I've read it a few times to be sure - that a tax be created such that net after-tax income for any filer is limited to 36 times the gross median household income. There are conceptual errors in the presentation such as comparing averages to median which changes some of the answers by a factor of 3x - but let's move past the sloppy academic work and on to the impact.

Using the most recent IRS data we have the median US household income is about $51,000 (versus an average of about $80,000). Using the formula presented by the authors this would result in a marginal tax rate of 100% on any amount resulting in after tax income of $51,000 x 36 or $1,836,000. I'll let that sink in for a second, but note that this would actually impact only about the top 0.3% or about 480,000 households.

Now aside from hitting the US Senate and some in the House in their own pocketbook this will not be received well by the likes of our own recently departed Albert Pujols ($25.4 million per year will be cut by about $23 million), any one of a number of Hollywood notables, but of course the key target - business people - are likely to have a significant change in behavior which I'll let you predict. This is made even more unusual since one of the authors has written a book on incentives which I need to go out and obtain to understand what I have missed on that topic.

I'll assume that if called for a vote the Senate would veto this out of self preservation but forecast that we see something like this over the coming years as the US struggles to deal with budget issues and an increasing inability to raise revenue or slice expenses. And I'll leave Chuck and Chris to determine where that takes the US dollar.

Both Frank and I agree that this stands no chance of getting through the Senate, where quite a few Senators would be hit by the cap. But it does illustrate that the larger than life problems we face are going to generate some pretty dramatic proposed solutions. Our debt and deficit problems here in the US or those in Europe won't be fixed by small little steps, and our current habit of just kicking the can down the road only serves to make the problems even larger.

And I will close out today's Pfennig by thanking all of the readers who sent me messages about yesterday's Pfennig. I agree with most of your comments, the politicians in Washington DC are the ones who should be brought to justice, not just the Wall Street bankers and scapegoats at the mortgage giants. Thanks again for reading, and for sending me your comments.

Recap. The euro was able to push higher after Spain found more than enough buyers for their debt. German business leaders are positive, and the EU countries pledged 150 billion euros to the bailout fund. The UK refused to commit funds, and the pound sterling dropped as home prices continue to fall. The Riksbank cut Swedish interest rates by .25% causing the krona to move higher. Finally, oil prices have been moving up, bringing the CAD$ and NOK along with them.

Currencies today 12/20/11. American Style: A$ 1.0038, kiwi .7654, C$ .9704, euro 1.3110, sterling 1.5682, Swiss $1.0768, European Style: rand 8.25, krone 5.8807, SEK 6.8473, forint 228.99, zloty 3.4002, koruna 19.4191, RUB 32.049, yen 77.81, sing 1.3007, HKD 7.7824, INR 52.89, China 6.3466, pesos 13.7669, BRL 1.8485, Dollar Index 79.729, Oil $96.16, 10-year 1.87%, Silver $29.40, and Gold. $1,611.30

That's it for today. Spent a late night at my son's hockey game which he won 3-2, and he has another this evening. As I mentioned in the opening paragraph, the rain continues here in St. Louis, and is expected to last through most of the week. We had a good day on the trading desk yesterday, and it looks like today will be another busy one. Hope everyone has a Terrific Tuesday, and thanks for reading the Pfennig!!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 12-20-2011 10:30 AM by Chuck Butler