Worries about Russia and a slowdown in China send investors to havens
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In This Issue.

* Dollar benefits from safe haven flows...

* Kiwi to benefit from interest rate increases...

* Precious metals tick higher as ETF flows return...

* Treasury yields continue to rise...

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

Worries about Russia and a slowdown in China send investors to havens...

Good day. Right about now Chuck is sitting at the airport here in St. Louis waiting to board a plane which will take him to what he considers 'heaven on earth' - Cardinal Spring Training. As you all can tell from his build up, Chuck has been looking forward to this day for quite a while and now he is off to enjoy the warm weather and daily trips to the ballpark. And he is leaving just in time as our flirt with spring here in St. Louis has come to an abrupt end. Temps above 80 degrees yesterday have given way to freezing temperatures and wet snowflakes as I drove in this morning; talk about a see saw! As Chuck told all of you, Mike and I will be splitting up the writing responsibilities through the end of the month as it takes two of us to fill the big shoes of Chuck!

The dollar has been swinging a bit less violently than the St. Louis weather, heading back to the positive side of the ledger vs. most of the currencies yesterday. The Japanese yen was the largest benefactor of investor worries concerning Ukraine's Crimean peninsula. The economic slowdown in China also sent currency investors into the traditional safe havens of the yen, Swiss Franc and the US dollar on what turned into a 'risk off' day. Many of you are probably wondering how the Japanese yen could possibly be seen as a 'safe haven' currency - what with the tremendous amount of debt which they have accumulated and the deflationary slump they have been in over the past couple of decades. I can point to one major reason the yen typically rallies on these 'risk off' days and that is the carry trade.

Readers of the Pfennig have heard all about the carry trade over the years, but for those of you who are new to class I'll give the quick 'elevator' explanation of what has been the most popular currency investment strategy over the past several years. The carry trade is established when investors borrow a currency at very low interest rates and then swap that currency into one that has higher rates. As long as the relationship between the two currencies involved in this trade remains stable, the investor is able to book the difference between these two interest rates (the CARRY). But with the compression of global interest rates, this carry has narrowed a bit and in order to really take advantage of this trade many institutional investors have turned toward leverage.

With near zero interest rates over the past 20 years and some of the world's largest banks, the Japanese yen has become one of the most popular funding currencies for the carry trade. Investors take out loans in the yen and then swap the currency into some of the higher yielding currencies of Australia, South Africa, and more recently the Brazilian real. Everything is just fine as long as the global economy is humming along and these high yielding currencies remain in demand. But at the first sign of trouble in these emerging markets, or if/when a 'macro' event increases the risk environment these highly leveraged trades have to be unwound which leads to selling of the EM currencies and the re-purchase of the funding currencies (in my example the Japanese yen). The Swiss Franc and US$ have also been used as funding currencies, but the yen is by far the most popular and therefore is typically the currency which rallies the most during 'risk off' days.

Whew, I went on sort of a tangent there, but I thought it was valuable to share my thoughts on why a currency with such abysmal economic fundamentals could be considered such a 'safe haven'. Ok, abysmal is probably a bit strong as things in Japan have been looking up lately but I still cringe whenever I read people are buying it for safety. I guess the same could go for the US$ as we have certainly been racking up a pretty good amount of debt ourselves. But with the US$ remaining as the reserve currency, I can see where investors could want to move back into dollars as global risks heat up if for nothing more than liquidity concerns.

With the safe haven currencies seeing some buying, the currencies traditionally occupying the other side of the trade were sold. The South African rand fell the most, and the Aussie dollar also weakened for a fourth straight day. The fall in the AUD was helped along by a report from the Melbourne Institute which said their gauge of consumer sentiment fell to 99.5 in March from a reading of 100.2 in the previous month. Another report released yesterday by the National Australia Bank Ltd. showed confidence among businesses also worsened in February. This combined with continued worries over China's announcement that exports fell by over 18% YOY had investors questioning the future growth prospects of the Australian economy.

But their neighbors across the Tasman Sea don't seem to be attracting the same concerns from investors. The New Zealand dollar was able to hold fairly steady during the trading day and is up ever so slightly vs. the US$ this morning. As Chuck as suggested, the Reserve Bank of New Zealand will likely become the first developed nation to raise interest rates since 2011 during tomorrow's meeting. These higher interest rate expectations, along with an improving trade picture have helped propel the kiwi to become the best performer of all major currencies so far this year, up almost 3% thus far. Recent increases in New Zealand house prices are stoking inflation concerns and pressuring RBNZ's Governor Graeme Wheeler to increase interest rates. We expect the RBNZ to announce a 25 bps at tomorrow's meeting, but this won't be a 'one and done' interest rate increase; instead we see the RBNZ continuing to increase rates through the end of the year. These higher rates will provide a nice 'floor' for the kiwi as international investors continue to search the globe for yield.

Readers may think we had some big moves in the currency markets after reading the first half of today's letter, but while it was a 'risk off' day the markets were fairly muted. The difference between the best performing currency of the Japanese yen and the worst performing currency of the South African rand was less than 1% - so you can see there just wasn't a whole lot going on. It was a very slow day for data here in the US, with Wholesale Inventories the only data worth looking at. Inventories were predicted to have increased .4% during January, but instead they showed a slightly larger increase of .6%. The December reading was also revised up slightly to an increase of .4%. Wholesale sales fell 1.9% after a revised increase of .1% in December. Inventories are rising, but the question remains if this is in reaction to companies preparing for greater demand or if it is due to falling sales.

We will get a partial answer to this question tomorrow when we will see the Advance retail sales for February. The BHI has predicted a weak number, and the 'official' estimates are showing an expected increase of just .2% MOM. We will also get the weekly initial jobless claims tomorrow which are predicted to remain at around 330k new filings. We won't have any major data releases today, so I expect another fairly muted trading day.

While I may question the 'safe haven' status of the Japanese yen, I don't question the status of the precious metals as a place for investors to 'hide' during time of global uncertainties. Gold rose yesterday as increased fears regarding the crisis in Ukraine and more worries about global growth pushed some investors toward traditional safe havens. Tensions continue to heat up in Ukraine, with Europe starting to step up the pressure on Russia. In a trading pattern which seems all too familiar, the yellow metal flirted with the $1,350 level, and actually traded through it for a short while before closing just shy of it. As Chuck suggested, sentiment for the precious metals have definitely shifted, with individual investors pumping money back into the exchange traded funds. The SPDR Gold Trust announced its holdings rose 7.5 tonnes on Monday, the biggest daily inflow since February 13.

The world's largest Platinum ETF also saw large inflows during the beginning of the week. Platinum started Tuesday's trading day with nearly a $25 drop, but recovered quickly as strike talks between platinum miners and companies broke down. Interest in Platinum by individual investors has increased dramatically in recent years, and we have seen an uptick in the purchases of our platinum unallocated Metal Select accounts here at EverBank. We have also just started offering Platinum Eagle coins which are again being produced at the US mint after a 5 year hiatus. The increase in automobile sales in China and the developing world is predicted to increase industrial demand for both platinum and palladium which are used in catalytic convertors. You combine this increase in industrial demand with a new investor demand and then throw in an extended production strike and you certainly have a 'supportive' environment for these precious metals.

For What It's Worth. Joseph Stolzer, who works over at EverBank's affiliate, EverBank Wealth Management, sent me an update on the markets which I thought was perfect for this morning's FWIW section. He produces a weekly report and this week's section on Treasury yields jumped out as something I should share with all of you Pfennig readers; so take it away Joseph:

The ten year treasury yield moved significantly last week driven early in the week by the calming of Ukraine issues and then later in the week by the strong NFP number. Despite the 20 bps move, the 10 yr. yield finished the week at 2.79%. Assuming that we get back to a 3% yield as seen at the end of the year, this implies that we have at least another 20 bps move remaining. I also continue to hear 3.5% as a 2014 year end target for bond yields which would imply that a move in the range of a 100 bps increase in yields this year is possible. What would support this increase in yields? Strong economic data and a continued Fed tapering - if the soft economic data that we have seen recently is indeed due to weather related effects (which I feel is true), then we should expect that pent up demand will boost economic data as temperatures normalize. What are the risks to our positioning? In the short term the risk is another increase in tensions in the Ukraine. In the long term, the risk is that the economic data continues to disappoint. And as always, there is the risk that the Fed does something that is not well communicated to the markets - like halting tapering at the next meeting.

Chris again, thanks to Joseph for agreeing to let me share his opinions on the 10 year moves last week. I will look to share more of these weekly updates from our affliates over at EverBank Wealth Management in future Pfennigs.

To recap. The currency markets were not quite as volatile as the St. Louis weather, with the dollar drifting higher as investors moved into 'safe havens'. The Japanese yen and Swiss franc both benefitted from a reversal of the carry trade and the high yielding currency of South Africa was sold. Aussie had another tough day, but the New Zealand dollar rallied on expectations of the first interest rate increase since 2011. Precious metals all rallied as global concerns sent investors to seek the shelter of the hard metals. And I closed out today's Pfennig with Joseph Stolzer's thoughts on the recent moves in the 10 year treasury yield.

Currencies today 3/12/14. American Style: A$ .8936, kiwi .8457, C$ .8952, euro 1.3861, sterling 1.6580, Swiss $1.4116. European Style: rand 10.9050, krone 5.9843, SEK 6.3883, forint 226.18, zloty 3.0473, koruna 19.725, RUB 36.5125, yen 102.70, sing 1.2691, HKD 7.7649, INR 61.175, China 6.1343, pesos 13.3063, BRL 2.3618, Dollar Index 79.789, Oil $98.82, 10-year 2.746%, Silver $20.90, Platinum $1.463.24, Palladium $761.50, and Gold. $1,357.40

That's it for today. I got to see a great Blues game last night, but unfortunately they lost in overtime to the Dallas Stars. With the overtime game, I stayed out past my bedtime so I'm dragging a bit this morning. The Blues are at the top of the NHL right now, and I'm hoping they can carry that momentum deep into the playoffs this year (A Stanley Cup would certainly be nice!). My son Brendan had a great day yesterday; getting news that he was accepted to Washington University here in town and he also received the Hobey Baker Character award from his high school hockey team. I just can't tell you all how proud I am of Brendan - he has worked hard and has grown into quite a young man. Ok enough of the sappy stuff - time to get this out the door. Hopefully you all have a Wonderful Wednesday and thanks for reading the Pfennig!

Chris Gaffney, CFA
Vice President
EverBank World Markets

Posted 03-12-2014 12:01 PM by Chuck Butler