Rumors have the ECB announcing limitless stimulus...
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In This Issue.

* ECB to announce limitless stimulus...

* Sweden cuts rates...

* Canada's Carney pushes against the tide...

* Gold tops $1,700...

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

Rumors have the ECB announcing limitless stimulus...

Good day. The morning is sure starting out a bit better than yesterday so hopefully that is a sign of things to come. I'll start this morning's Pfennig with a quick update on Chuck. I spoke to him yesterday afternoon, and while he is still in a lot of pain, he is expecting to be released from the hospital sometime today. The infection which took hold in his leg is being helped by some strong antibiotics and once that clears up they will re-schedule his surgery. Chuck didn't like having to push the surgery off, but they need to get the infection under control first.

Today we will find out if Mario Draghi can deliver on his pledge to do 'everything in his power' to protect the euro. The news wires are full of stories regarding today's announcement; in fact if you didn't know better you might think Draghi had already made his announcement. The euro is back up above $1.26 after two ECB officials let it out that Draghi's plan will include unlimited buying of European debt with up to 3 year maturities. The ECB will focus on government bonds rather than a broader range of assets and there will be no public cap set on yields. By not placing a cap on the bond buying plan, the ECB hopes to avoid having to constantly come back to the markets to assure them they will continue with the plan.

The rumored plan also involves the 'sterilization' of the new bond purchases. Buying bonds from the secondary market is akin to printing money, it is designed to place liquidity back into the market. As we have pointed out several times in the past, this quantitative easing is inflationary as it puts more money into the markets. But the bond buying plan which will be announced today by the ECB will be matched by the removal of an equivalent amount of money from elsewhere in the system. The sterilization was probably a concession worked out with Angela Merkel who told lawmakers yesterday that she can accept temporary ECB bond buying. Merkel also pushed for tough terms for any country which asks for aid from the rescue fund. Draghi has been stressing the conditionality of the bond buying program and said the ECB would stop buying the bonds of any government that fails to live up to its agreements.

It will be interesting to see exactly where they find that equivalent amount of money to be removed. Perhaps they will lower the deposit rates to negative. 30 of 58 economists surveyed by Bloomberg predict the ECB will cut the benchmark rate from .75% to .50%. And the deposit rate has typically been set 75 basis points lower than the benchmark, so that would push the rate the ECB pays banks on their deposits into negative territory. Banks would have to pay the ECB for any deposits they keep with the European central bank. But this would probably not remove enough money from the system to match the new bond purchases, so the ECB will have to look elsewhere to remove liquidity. Hopefully ECB President Draghi will provide some details later today.

As I mentioned earlier, the euro is already acting like the plan has been announced, rising back up to levels we haven't seen since the end of June. The risk today is that some part of the plan which was leaked out is not accurate, or there is not enough detail given by Draghi on the sterilization. But if Draghi delivers what has been rumored, the euro will likely hold these levels and go back into a 'holding' pattern waiting on next week's German court ruling. In fact, the plan is already having its intended consequences, as both Spanish and Italian interest rates have moved lower.

You wouldn't know it from scanning the news wires, but there are several other central banks meeting this week. The Bank of England will announce its rate decision today at noon, and is widely expected to keep its rates unchanged at .5%. More importantly, the BOE is expected to keep their bond buying target at 375 billion pounds. England's economy contracted in the first and second quarters, and the latest data show house prices continue to fall.

Sweden's Riksbank cut its benchmark rate 25 basis points in a move which surprised many (including me). As I reported in yesterday's Pfennig, Sweden's Prime Minister Fredrik Reinfeldt has been telling exporters to get used to the strong krona. But the central bank seems to have caved in to calls from the unions and exporters to stem the rise of Sweden's krona. "During the summer the krona has appreciated faster than expected and productivity has also been unexpectedly high," the Riksbank said. "Inflationary pressures are therefore expected to be lower than was forecast in July." The bank did say the rate would remain unchanged 'until the middle of next year'. But two of the bank's six members are still in favor of further cuts, wanting to reduce rates to 1% according to today's statement. The future direction of Swedish rates will probably depend on what happens to the Euro. If the ECB is successful in calming the markets and the euro continues to appreciate, the pressure for further rate cuts in Sweden will abate as safe haven flows out of the euro will slow.

The Swiss have also been feeling the pressure of safe haven flows, and a report released by JPMorgan Chase & Co predicts the franc won't be able to hold the peg with the euro. The analysts at JP Morgan think the Swiss currency will breach its 1.20 level vs the euro and appreciate to 1.15 per euro by the end of the year. The SNB has been increasing currency reserves in order to protect the peg, with reserves swelling to an equivalent of 67% of the Swiss GDP. But the recent strength of the euro has take a bit of the pressure off the Swiss franc, and there were actually rumors floating through the currency markets that the SNB would be moving the peg even higher (weakening the Swiss franc vs. the euro).

Chuck has always said intervention and arbitrary pegs can only work in the short term. The markets have more money than the central banks (even the Swiss don't have enough to fight the currency traders) and the currencies will eventually break free from the intervention with the markets taking them to their 'true' values. The Swiss franc is not something I would chose to invest in currently, as the SNB has pledged to keep the peg in place. But eventually the Swiss franc may present investors with a good opportunity as the peg is broken and it is set free to move higher.

The Bank of Canada met yesterday and left rates unchanged as most had expected. But BOC Governor Mark Carney sounded hawkish following the rate announcement. According to Carney, "some modest withdrawal of the present considerable monetary policy stimulus may become appropriate." This is one of the reasons Chuck has been talking about the Canadian dollar; the central bank is acting like it will be one of the first to start moving interest rates higher. Currency investors, like all investors lately, are constantly in search of yield, and any increase in interest rates should help push the currency higher.

Canada's economy has been 'near its production potential' according to the central bank. A report released last week showed the Canadian economy expanded at a 1.8% annual pace in the second quarter. Inflation, reported at 1.3% in July, is expected to challenge Carney's 2 percent target as the year ends. Commodities make up a large percentage of Canadian exports, so the recent rise in oil and metals will put additional pressure on the inflation rate.

As I just mentioned, both oil and the metals moved higher on global growth optimism. Crude oil moved back above $96 to stay in its recent range between $95 and $98. Gold topped $1,700 an ounce for the first time in over 6 months and silver moved awfully close to $33. The metals rose due to the additional stimulus which is expected to be announced today. The stimulus is inflationary, and metals are traditionally seen as an inflationary hedge. I know the ECB has said they would be 'sterilizing' the bond purchases, but apparently the metals traders still think the stimulus will have a long term inflationary impact. Gold was also helped by a couple of calls by the big boys on Wall Street. Jeffery Currie, the head of commodities research at Goldman Sachs said gold would be at $1,840 by year end during a Bloomberg TV interview. And not to be outdone by Goldman, Bank of America Merrill Lynch analysts Sabine Schels and Michael Widmer said in an emailed report that gold prices would climb to $2,000 per ounce by the end of the year. Welcome to the party, as Chuck and I have been using a slide during our last several presentations which states the same thing; gold will challenge its' all time highs during 2012 as central banks continue to introduce new stimulus into the global economy.

With gold moving higher, the commodity currencies were also up. The South African rand was the best performer overnight, snapping a 3 day decline vs. the US$. Confidence over the global growth prospects were sent higher by rumors of the ECB bond buying program, sending all of the high yielding currencies higher. The Brazilian real also moved higher vs. the US$ after gross domestic product in the South American country expanded at .4% during the 2nd quarter, the fastest pace in a year. But growth in this emerging market is still dramatically lower than the lofty rates which it had enjoyed in years prior, and there is little evidence of a strong recovery. Industrial output in Brazil fell 2.5% in the 2nd quarter and investment declined .7%, but these were offset by a positive 4.9% growth in agriculture and a smaller .7% increase in the service sector. Brazil will remain a very volatile currency, and the Brazilian government looks to continue to try and keep its value down in order to stimulate exports.

The Aussie dollar moved higher after Australia's jobless rate unexpectedly declined. The unemployment rate fell to 5.1% from 5.2% in July, vs. an expected increase to 5.3%. The good unemployment news, combined with a more positive outlook for the global economy allowed the aussie dollar to temporarily reverse course and book a slight increase. With the employment staying near 5% which is seen as fairly close to 'full employment', the calls for further cuts in the interest rates have quieted a bit. As I stated yesterday, the Australian dollar is still in a technical downward pattern, but looks to be bottoming out at just above parity.

With the ECB announcement early this morning, the markets will now turn toward tomorrow mornings employment report here in the US with an eye toward the FOMC meeting next week. This morning's weekly jobs data should give us some indication of tomorrows number, with expectations of a fall in the number of new jobs during the month of August. Should make for an exciting day!

To recap. Draghi is set to announce unlimited bond buying to include a 'sterilization' of the new money. The euro is moving higher on the news. BOE is expected to leave rates unchanged, as did the Bank of Canada. The Swedes cut rates in an effort to weaken the krona. The Swiss are feeling the pressure of maintaining their peg, and several analysts believe it will break before the end of the year. Gold and commodities moved higher, with many analysts falling in line with Chuck's call for a new high. And the commodity currencies moved higher even pulling up the beleaguered Australian dollar.

Currencies today 9/6/12. American Style: A$ $1.0246, kiwi .7973, C$ $1.0123, euro 1.2617, sterling 1.5903, Swiss $1.0481. European Style: rand 8.3624, krone 5.825, SEK 6.7189, forint 226.63, zloty 3.2924, koruna 19.5472, RUB 32.2073, yen 78.44, sing 1.2454, HKD 7.7569, INR 55.7513, China 6.3430, pesos 13.0858, BRL 2.0391, Dollar Index 81.137, Oil $96.49, 10-year 1.61%, Silver $32.85, Gold $1,709.65, and Platinum $1,584.32

That's it for today. It was great speaking to Chuck yesterday, he sounds good. In typical Chuck fashion, he called me concerned about others. He was watching the Cardinal game yesterday (another Cardinal's loss) and saw that a strong earthquake had struck Costa Rica. We have some good friends, the Aden sisters, who live down in Costa Rica; so he wanted me to send them a note to make sure everyone was ok. It turns out the quake was very strong but thankfully both Pam and MaryAnne Aden's families were unharmed. We will finally got a break from the rain today and it looks like it is going to be a beautiful day! Thanks for reading the Pfennig, and go out and have a terrific Thursday!!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 09-06-2012 10:26 AM by Chuck Butler
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