Waiting on the FOMC taper decision...
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In This Issue.

* FOMC taper decision rules markets...

* Euro-zone data pushes euro higher...

* AUD falls but NZD set to rally...

* Brazil's central bank pledges support for the real...

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

Waiting on the FOMC taper decision...

Good day. And welcome to another week. How was your Friday the 13th? Mine was pretty uneventful but we had a busy weekend here in St. Louis as we worked over the weekend to get an upgrade installed on the computer system which tracks all of our World Market accounts. The installation went off mostly without a hitch thanks to the hard work of our IT group, and I got out of here in time yesterday to go watch the St. Louis Rams beat up on the New Orleans Saints (a very surprising outcome!).

The direction of the dollar wasn't much of a surprise overnight as it continued the slide it began on Friday. The dollar started its slide Friday morning after the Producer Price numbers showed inflation remains in check. The PPI MoM figure actually showed prices dropped .1% in November following a .2% drop in the previous month. The YoY figure showed a slight increase, printing at a positive .7% rate, slightly lower than the expectations of a .8% increase. I know many of you Pfennig readers would argue the fact that the US economy is free from inflation and I would have to agree as my wife and I begin to realize the cost of sending our high school senior to college. But the FOMC isn't worried about the cost of college or healthcare; they focus on the 'official' numbers of CPI and PPI which do not currently reflect any inflation pressures. And the largest driver of inflation is typically wage pressure, something which doesn't look like we are going to have to worry about for a while here in the US. And this lack of inflation pressure is one of the reasons I believe the FOMC will hold off any tapering of their bond purchases until after the 1st quarter of 2014.

The direction of the dollar certainly suggests currency investors are starting to shift their expectations of a taper further out on the calendar. The latest surveys show 34% of economists expect the Fed to begin to taper at this week's meeting, with the largest majority looking for the taper to begin instead during the first meeting of 2014. This week's FOMC meeting will definitely be the primary focus of investors, overshadowing all other data releases here in the US. These data releases include US PMI, Labor costs, TIC flows, and Capacity Utilization this morning, Inflation data in the form of CPI on Tuesday, and Housing starts and Building permits on Wednesday morning before the big FOMC announcement. Following the announcement we will get the weekly jobs information on Thursday along with existing home sales data and Leading index. And then we will close out the week with GDP for the 3rd quarter along with the KC manufacturing activity number. A very busy week with the markets largely focused on Wednesday's FOMC 'taper' decision.

Even though they will be overshadowed by the FOMC decision, a few of the data points released this morning deserve some additional focus. First the Nonfarm Productivity and US labor costs suggest wage inflation will remain subdued as productivity is expected to show a 2.8% increase in the 3rd quarter while Unit Labor costs are projected to have decreased 1.4% during the same period. And the capacity utilization figure confirms that the labor market will continue to be 'soft' as it is expected to show just a slight increase at 78.4% during November compared to a 78.1% reading in the previous month. The Capacity Utilization number is one which Chuck watches closely as it indicates how 'tight' our manufacturing sector is and just how much capacity is left in the current factories. A reading below 80% suggests we still have some room to grow. On the positive side, data from the Fed today is expected to show US Industrial Production rose .6% last month from October when it fell .1%; and a gauge of manufacturing in the New York region is expected to have advanced to a 3 month high. With mixed data expected, the markets will should continue to drift until Wednesday's FOMC announcement.

Moving across the 'pond' data releases are being credited with driving the Euro higher this morning. Euro-area factory output surprised economists, with the PMI figure increasing to 52.7 in December; almost a 3 year high. That figure was significantly higher than November's 51.6 reading and beat expectations of a level of 51.9. This figure supports Chuck's thoughts that the Euro-zone GDP will begin to gain momentum in 2014 which should continue to support the euro. As I wrote in Friday's Pfennig, many of the large currency desks believe the ECB will get more aggressive in their quantitative easing efforts next year, but we continue to believe they will instead keep a more hawkish tone. Instead of flooding the markets with fresh liquidity, I believe the ECB will continue to 'jawbone' the markets; suggesting they will stand behind the euro but not taking any significant intervention in the markets.

The announcement by German Chancellor Angela Merkel of the names of her third term cabinet also helped push the euro higher. These appointments confirm Merkel was able to successfully put a ruling coalition together and cements her parties control of the EU's largest economy. The 'anchor' of Merkel's cabinet is Wolfgang Schaeuble who will continue to serve as Germany's finance minister. Merkel has confidence in her finance minister stating that "Wolfgang Schaeuble is somebody who is in favor of the stability of the euro and the policy connected with that for us in Europe" . Merkel also suggested that she will not be in favor of creating any additional debt in steering the German economy stating "We will have the opportunity in the coming legislative period to come through without generating new debt as a contribution to generational justice." Those are some refreshing words to hear from a leader - worrying about the impact today's spending has on our future generations. We will get an initial indication of the opinion of German business leaders regarding the new/old leadership with the release of German business confidence on Wednesday. The confidence figure is expected to be the highest in more than 1 ½ years according to the latest Bloomberg survey. More good news for the euro going forward.

The pound sterling fell a bit on Friday and is one of only 4 major currencies which are down vs. the US$ during December. UK inflation data which will be released tomorrow is expected to show inflation slowed to 2 percent last month, meeting the BOE's target for the first time in four years. This would take some pressure off BOE Governor Mark Carney to increase interest rates in order to combat price pressures. This slower inflation has lowered interest rate expectations, putting some price pressure on the pound vs. the euro and US$.

Norway's krone strengthened vs. the US$ ahead of Wednesday's FOMC meeting. Both the NOK and AUD had been sold ahead of this week's FOMC decision on tapering as investors increased bets on a December reduction in bond buying. This sets the stage for a 'relief rally' in both of these currencies if/when the taper does not occur this week.

But unlike the NOK, the Aussie dollar has continued to fall ahead of the meeting. The AUD dropped last week after the RBA Governor Stevens stated he would prefer to see the AUD trade down to .85, a drop of approximately 5% from its current level. Minutes of the RBA's last meeting will be released tomorrow, and will likely reflect Stevens' commitment to reduce the value of the AUD in order to stimulate the economy through increased exports. Again, there seems to have been a lot of AUD/US$ positioning ahead of the FOMC decision with the thought that the Fed will be tapering during their December meeting. If the Fed does not taper their bond purchases this week, we could see this positioning reverse which would likely spike the AUD$ higher. In a split with their 'kissin cousins across the Tasman', the New Zealand dollar has continued to increase. Some of this strength was due to a report which showed Consumer Confidence in New Zealand rose to a 4 year high, coming in at a reading of 120.1 for the 4th quarter. Another report showed the November Performance of Services index was 56.3 vs. a reading of 57.7 in October; but any reading above 50 indicates continued expansion. Other data indicate that demand for labor is accelerating in New Zealand and could push the unemployment rate below 6% in the coming months.

The kiwi seems to have shaken off data which showed Chinese manufacturing may be slowing. A preliminary reading of China's PMI of manufacturing fell to 50.5 this month from 50.8 in November. This reading was slightly lower than the 50.9 estimate by Bloomberg. China is the largest trading partner for both New Zealand and Australia, with both of these countries relying on their raw material exports into the world's second largest economy. Investors were also worried by the Communist Party's warning last week that the economy faces 'downward pressure' and another warning by central bank Governor Zhou Xiaochuan that borrowing costs may be 'relatively high' after interest rates are liberalized.

A couple of popular emerging market currencies began to advance vs. the US$ as the Brazilian real and Indian rupee both moved higher. Brazil's real advanced after central bank President Alexandre Tombini reiterated the central banks commitment to extend intervention in the currency markets into 2014 to offset any possible 'taper' by the FOMC. The emerging market currencies risk a fall if / when the FOMC tapers, as a taper would be seen as possibly reducing the amount of money available to these emerging economies. Tombini has stated that the $60 billion intervention program announced in August to support the currency will be extended into next year. The real may need the additional help this intervention provides, as data showed Brazil's current account deficit rose to $82 billion in the 12 months ending October, 3.67% of GDP which is the widest since March of 2002.

To recap. The dollar continued to slide as the markets focus on the possibility of a taper by the FOMC on Wednesday. The euro rallied after Euro factory output surprised on the upside and German Chancellor Merkel announced her new cabinet. The pound fell a bit and the Norwegian krone gained vs. the US$. The Aussie dollar remains under pressure but could rally if/when we do not get a taper by the FOMC. And the kiwi, in contrast to the AUD moved higher in spite of a poor PMI reading out of China. And some emerging market currencies rallied vs. the US$ but remain in a fragile position as the taper will dominate trading this week.

Currencies today 12/16/13. American Style: A$ .8928, kiwi .8255, C$ .9443, euro 1.3785, sterling 1.6324, Swiss $1.1293. European Style: rand 10.268, krone 6.1320, SEK 6.5558, forint 218.06, zloty 3.029, koruna 19.988, RUB 32.85, yen 103.02, sing 1.2555, HKD 7.7536, INR 61.764, China 6.1124, pesos 12.9106, BRL 2.3270, Dollar Index 79.987, Oil $97.15, 10-year 2.8573%, Silver $19.48, Platinum $1.351.00, Palladium $713.20, and Gold. $1,229.71

That's it for today. An unbelievable Rams game yesterday; makes you wonder just where that team has been hiding! I went down to the game with my mom and my niece who is home from college. We had a great time watching the surprise victory! A couple of you asked how I did on my weigh in on Friday - unfortunately I gained a pound but I wasn't the only one on the desk who was in the plus column so I guess there is some comfort in not being the only gainer. It is a long contest (90 days) and slow and steady will hopefully win the race. I am running a bit late this Monday morning, so I will leave you with my hope that you all have a Magnificent Monday!

Chris Gaffney, CFA
Vice President
EverBank World Markets

Posted 12-16-2013 11:58 AM by Chuck Butler
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