Focus Still Remains on the US Economy...
Daily Pfennig

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In This Issue.

* US equity markets hit new highs...

* Dollar moves higher after positive economic data...

* Brazil, Canada, UK, and the European central banks start their meetings...

* China's leader gives his final report...

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

Focus Still Remains on the US Economy...

Good day... We got an unexpected snow storm here in St. Louis yesterday; not much accumulation but enough to make the commute home a bit tricky. I hear the folks just north of us are getting blanketed with up to 10 inches up in Chicago. The dollar took an unexpected turn upwards after a report showed the service industries expanded at the fastest pace in a year. And the Dow reached an all time high yesterday, fueled by the easy money of several rounds of quantitative easing.

Boy was I ever wrong when I closed out yesterday's pfennig with the statement that there wasn't any important releases scheduled here in the US. No excuses, I just totally missed what apparently turned out to be a very important piece of data which was scheduled to be released first thing yesterday morning. The Institute for Supply Management's non-manufacturing index was released yesterday morning, and unlike similar gauges in China and Europe, the ISM gauge for the US unexpectedly increased. The index came in at 56 in February, compared to a 55.2 reading the month before. The forecast called for the index to fall to a reading of 55, so the increase caught most investors off guard (especially those of us who weren't even aware the data was going to be released!). The US data contrast dramatically with the slower growth of the service industry in the world's second biggest economy - China. As I reported in Monday's Pfennig, the Chinese service index expanded in February at the slowest pace in 6 months, and caused some investors to start to worry about the resilience of the global recovery.

The ISM number usually isn't a 'market mover', but the US equity markets had been pushing higher so the surprisingly positive number was just the catalyst needed for US equities to set new all time highs. While the ISM data may have supplied the final push, the equity rally which has been occurring since the turn of the year has been built on the easy money of Bernanke's stimulus programs. This is why there is so much concern on if and when the Fed will stop feeding the markets.

I won't make the same mistake today, and will let you know there are three different reports scheduled to be released today which could impact the markets. First we will get the MBA Mortgage Applications which are expected to show a major improvement over last month's negative reading. More importantly we will see the ADP Employment Change report which is expected to show companies added positions in February. This report is typically seen as a 'preview' of the Labor Department's job report which is scheduled to be released on March 8. And later this morning we will get Factory Orders for the month of January when they are expected to have fallen 2.2%. The currency and equity markets seem to be focusing on the ADP report (no surprise since this is the one which is predicted to be the most optimistic). And finally the US Fed's Beige Book will be released this afternoon and will probably indicate the US economic recovery is continuing, but is still somewhat fragile. I don't believe there will be anything in the beige book which will indicate the US will put an end to the stimulus efforts sooner rather than later.

Chuck sent me some thoughts on the sequester which was signed into law last Friday. So without further ado heeeeerrrreeee's Chuck:

Well... the world didn't come crashing down last Friday, or yesterday, or today... Know why? Well, I've been telling you that the $1.2 Trillion in cuts, of which $85 Billion is for this year, is going to be against the projected rate of increase in Government spending over the next 10 years! That's right! Under sequestration, government spending increases by $2.4 Trillion over the next ten years, instead of $2.5 Trillion without it...

I saw a comment by one of my fave realist people, Ron Paul... He said, "so now we are speeding toward collapse at 100 miles an hour instead of 110 miles per hour." Pretty good analogy, eh?

Yes, there will be some minor changes but most of the cuts in increased spending comes from the defense budget, and trust me on this, it's not going to tarnish our claim as the world's greatest military. There's still plenty of money going to defense... If you lose your job, because of this, that's bad, and I don't want to see that happen to anyone. I've been cut loose before, and I know what it feels like... But... the "cut" ended up being the best thing to happen to me work-wise, as I found something even better! And you will too! And before you get mad at the lawmakers that allowed the sequestration to happen, think about the executive branch... In a recent tour of the Middle East, our new Sec. of State, announced that the U.S. would be sending another $60 million to the rebels seeking to overthrow the Syrian Gov't... Couldn't that money be better spent here?

But getting back to the sequestration... and just to put some numbers on the defense spending cuts... the defense budget is now set to increase at 18% in the next ten years, down from 20%... So... in the end, to me that is, I don't see the U.S. Gov't taking this debt problem seriously... I can see it now... What Me Worry? someone has taken over for Alfred E. Newman...

Me again. Thanks to Chuck for sharing his thoughts on the 'severe austerity measures' (or not) that are being forced on our government. I do get a bit angry listening to all of the folks on the radio warning us just how bad these spending cuts will be for our economy. I really think the 'big government' people are just scared that the public won't even notice these cuts have taken place, and will be more than willing to accept even more cuts in the next go around.

But enough on the spending cuts, let me get back to the currency markets. The dollar rallied Tuesday on the combination of the positive ISM data and the record level of the Dow. Currency traders are feeling a bit more confident in the health of the US economy, and this new found confidence leads to increased expectations that the Fed may end the latest round of quantitative easing earlier than currently expected. An early end to QE would be a positive for the dollar, just as prolonged quantitative easing will lead to a further weakening of the greenback. This confidence in the recovery in the US markets was also seen as a reason to start putting 'risk' trades back on and we saw the dollar start to lose ground overnight as investors sold haven assets in search of higher yields.

We are expecting to get an important piece of data out of Europe this morning as 4th quarter GDP will be released shortly. The Bloomberg estimate shows a median guess of a drop of .6% in Europe's GDP during the last quarter of 2012. This information could lead to a further sell off in the price of the euro as traders interpret the contraction as a reason for more policy easing from the ECB. Mario Draghi and his counterparts will begin their meeting today, along with policy makers in the UK, Canada, and Brazil. While there is little room for ECB policy makers to ease rates further, some believe we will hear a more dovish tone in Draghi's statement. There has been a push to get the ECB policy makers to 'ease' some of their austerity demands in favor of pushing more stimulus.

The Swiss franc followed the euro lower as traders moved away from 'safety'. One currency on the eastern side of the Atlantic which continues to perform well is the Swedish Krona which climbed to its strongest level in six months. The krona saw more buying after an index showed purchasing managers in the services industry are gaining confidence in this Nordic country's recovery.

Retail sales in the UK rose at the fastest pace in more than three years in February, and another report showed UK services unexpectedly accelerated last month. But even these two positive reports weren't enough to generate a sustainable rally in the pound. The problem is that a 'triple-dip' recession is still very possible, and most investors are expecting policy makers to discuss more quantitative easing at the BOE meeting which begins today. Analysts over at PIMCO are suggesting the pound sterling has further to fall. In a report released earlier this week, analysts predicted the Bank of England will resume asset purchases after already buying 375 billion pounds of debt. Outgoing BOE leader King and two other policy makers voted to expand the current QE program at the February meeting, but they were outvoted by the six other members. Many, including the analysts at PIMCO, believe King will possibly convince a majority of the BOE members to expand the stimulus plan at either this meeting or the next. Leaders at the BOE are also indicating they would like to see the Pound sterling continue to slide, which is certainly not good news for holders of this currency.

Central bank members will also be meeting in both Brazil and Canada, and both countries are expected to keep rates unchanged. The Brazilian economy is slowing again, as shown by the GDP number released last week which showed 4th quarter growth was less than economists expected. But there are still some who believe rates will need to go higher in Brazil as inflation jumped in January by the most in almost eight years. Lately, President Alexandre Tombini has taken a page out of Singapore's policy playbook and has allowed the Brazilian real to appreciate in order to alleviate some of this price pressure. The Brazilian real is the best performing currency over the past 3 months, appreciating 5.8% vs. the US$. Combine this currency appreciation with a fairly good interest rate and this has been a very good bet for currency investors over the past quarter.

Then there was this...PBOC plans currency reform and flexibility. Yi Gang, deputy governor of the People's Bank of China, says the central bank is getting ready to implement reform that will increase flexibility in the exchange rate. "We will continue to reform and open up," he said. "I'm confident that the renminbi exchange rate will be more balanced and flexible and basically stable."

To recap.Results of the February ISM non-manufacturing index came in better than expected and bucked the downward trend recently seen China and Europe. We'll see the February ADP employment numbers and January factory numbers first thing this morning and then the Fed's Beige Book release in the afternoon. Chuck gives us his take on the sequestration and this great quote from Ron Paul "so now we are speeding toward collapse at 100 miles an hour instead of 110 miles per hour." The dollar and the Dow rallied yesterday on the positive ISM data, but we'll see if the results of European 4th quarter GDP will derail any of the risk tolerances. Retail sales and services in the UK increased, but it doesn't look to be enough to prevent additional QE measures, according to many economists. The central banks in Brazil and Canada are expected to keep rates on hold.

Currencies today 3/06/13. American Style: A$ $1.0287, kiwi .8333, C$ $.9719, euro 1.3035, sterling 1.5088, Swiss $1.0596. European Style: rand 9.0533, krone 5.6974, SEK 6.3808, forint 229.42, zloty 3.1881, koruna 19.6175, RUB 30.6738, yen 93.43, sing 1.2463, HKD 7.7561, INR 54.72, China 6.2180, pesos 12.7066, BRL 1.9649, Dollar Index 82.16, Oil $90.73, 10-year 1.92%, Silver $28.80, Gold $1,575.75, and Platinum $1,592.25.

That's it for today. The Blues let a 3 goal lead slip away vs. the Stanley Cup champions last night, and the Kings scored 4 goals in the 3rd period to come back and win 6-4. Tough way to start their western road trip!! I'm sure Chuck was happy to see his Missouri Tigers avenge an earlier loss to Arkansas. Mizzou beat the team of their former coach Mike Anderson soundly, playing what was one of their best games of the season. March Madness is right around the corner, and I will have a couple of teams to watch this year as the St. Louis Billikens are currently ranked #15 in the country! Should make for a fun tournament. I have an 'off site' meeting to get to first thing this morning, so I will go ahead and hit the send button a bit earlier than usual. Thanks for reading the Pfennig, and have a Wonderful Wednesday!!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 03-06-2013 3:29 PM by Chuck Butler
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