In This Issue.

* Dollar floats higher in holiday trading…
* Data support view of an improving US…
* Wall Street predicts a lower euro (AGAIN)…

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

Dollar floats higher in thin holiday trading…

Good day. I hope everyone had a wonderful holiday, I know I did.  We hosted Christmas Eve, and then went to my sister's house yesterday. Both celebrations were fun with great food and lots of 'family time'.  But the holiday is over now, and some of us are right back at work (albeit not many as far as I can tell from my drive in this morning!).  The currency markets are largely 'on holiday' still as most of Europe has the rest of the week off.  The dollar drifted slightly higher in shortened trading hours on Tuesday, so let me share what I have been able to dig up.

The dollar is trending higher as 2013 comes to an end.  The dollar's strength is mainly due to rising expectations regarding the US economy's recovery.  The FOMC move to cut back their monthly bond buying by $10 billion is being seen as a sign policy makers feel the US economy is strong enough to stand on its own two feet.  And biggest concern regarding the taper, a sharp increase in interest rates, hasn't happened.  As you can see from our 'currency wrap up' the 10 year rates have slowly moved back up but remain just below 3% which I have to believe has the FOMC members pleasantly surprised.  The  Fed members seem to have succeeded in curtailing rate hike expectations for now.  But as both Chuck and I have pointed out, the FOMC has a lot less control on longer term rates than the rates on the shorter end of the curve.  Long rates are set by inflation expectations, and right now those expectations are being held in check.  But as the US economy gains strength, banks will begin to crank up their lending again, causing all of the liquidity the Fed has pumped into the markets to start moving.  This will accelerate the 'velocity' of money which could lead to a sharp rise in inflation.  The FOMC members have said they will pull this liquidity back out of the market as soon as they feel the need to, but will their timing be correct?  If they move too quickly they risk a quick end to the recovery, but if they wait too long we could see a spike in inflation.  While Chairman Bernanke and his compatriots on the FOMC will certainly be celebrating the way the markets have reacted to their latest move, they still face some very difficult decisions with regard to the timing of monetary policy in 2014. 

Data released on Christmas Eve showed orders for long-lasting US manufactured goods surged in November.  Durable goods orders were 3.5% higher last month after dropping a revised .7% during October.  The less volatile 'ex Transportation' number was also higher, rising by 1.2% vs. an expected increase of .7%.  This was the largest gain in 6 months and is certainly good news for the manufacturing sector.  Another piece of data which was released on Tuesday was the Non-defense capital goods orders excluding aircraft which is another indication of business spending plans.  The increase in this piece of data was even more impressive, rising 4.5% vs. expectations of a .7% increase. 

We also got another look at the housing market, and the data here weren't quite as rosy.  The Commerce Department said new home sales fell 2.1% during the month of November, to a seasonally adjusted annual rate of 464k.  This follows an impressive rise of 17.6% increase in the previous month (a number which was revised down from the originally reported 25.4% increase).  October's revised figure is still the highest level of new home sales since July of 2008.  So while the November housing data were a slight disappointment, the housing sector continues to show improvement.

So Tuesday's data certainly indicate Chairman Bernanke and the FOMC made the right decision last week to start the taper in January.  But the biggest challenge for the FOMC remains the stubborn labor market.  Today we get the weekly jobs numbers which are expected to show initial jobless claims remained fairly high at 345k last week.  Continuing claims are expected to have fallen slightly to 2,827k from a figure of 2,884k the previous week.  The weekly jobs report will end this week's data, and I don't expect much movement in these holiday thinned markets no matter where the data prints.

Then there was this.  As we get ready to turn the calendar over the news wires are full of 'Year in Review' stories.  One of these stories on Bloomberg caught my eye as it dealt specifically with the currency markets.  Readers will remember that at this time last year most of the major Wall Street banks were calling for the US$ to strengthen vs. the euro.  The story written by Bloomberg reporter John Detrixhe was titled “Wall Street's Failed Dollar Call Redoubled on Fed: Currencies”.  In it Detrixhe details some of the banks who are again calling for a drop in the euro in spite of their wrong call for 2013. 

“Barclays Plc, Deutsche Bank AG, HSBC Holdings Plc and UBS AG, four of the five biggest currency dealers, are among banks forecasting the US tender will rally 6.4% vs. the euro in 2014, according to the median estimate in a Bloomberg survey of 84 participants.  A year ago, a survey predicted a 3.7% gain for the greenback in 2013.  Instead, the 17 nation euro has appreciated 2.7% this year vs. the US currency, beating its major counterparts.”

The story goes on to explain many strategists expect the US economy to outperform its developed-market peers, enabling the Federal Reserve to print fewer dollars as it unwinds unprecedented monetary stimulus while Europe's central bank is seen easing further.  “The euro rallied the most this year against the dollar since 2007 after the region emerged from recession and the Fed maintained its $85 billion in monthly bond purchases longer than economists anticipated.” 

According to the Bloomberg survey, Deutsche Bank estimates the greenback will strengthen to $1.25 against Europe's currency by the end of 2014. HSBC sees the dollar gaining to $1.28 in the next 12 months.  But at least two big Wall Street banks are going against the consensus, with both Goldman and Citigroup predicting further strength from the euro.  “Goldman Sachs Group Inc analysts, who correctly predicted the dollar's slide against the euro this year, are betting against the consensus that the greenback will be among the best currencies to own in 2014.  The dollar will weaken to $1.40 per euro for the first time since October 2011 because reduced Fed stimulus is already reflected in the US currency's price, Thomas Stolper, Goldman's London-based chief currency strategist, said in an e-mailed response to questions two weeks ago.  Citigroup also sees the European currency gaining to $1.40 in 2014, after wagering a year ago that it would fall to $1.20 by December 2013, Bloomberg data show.”

These 'missed calls' are exactly why we typically don't make predictions on where any currency will be on any certain date.  The markets are just too unpredictable!  But we do try and look at the macroeconomic environment, along with the fundamentals of each country to try and gauge which currencies look positioned to appreciate vs. the US$.  But again, it is more important to be invested in the asset class of currencies as a whole rather than trying to predict where they will be trading at this time next year.  Asset class allocation and having a well diversified portfolio is the most important part of investing for the long term.

Recap. The dollar floated higher over the Christmas holiday as markets were very thin.  The durable goods data support the view that US manufacturing will continue to rebound.  New home sales were lower than expected, but still show the housing market is improving.  Today's weekly jobs data will mark the end of this week's data, and the markets are predicted to remain very quiet.  And according to the latest Bloomberg poll, 4 of the largest currency trading desks are predicting the Euro will fall in 2014 after making the same (INCORRECT) prediction last year.  Goldman and Citi are two which are going against the crowd (along with Chuck) to predict the euro will again book a nice gain vs. the US$.

Currencies today 12/26/13. American Style: A$ .8885, kiwi .8158, C$ .9411, euro 1.3695, sterling 1.6394, Swiss $1.1172. European Style: rand 10.2920, krone 6.1409, SEK 6.5594, forint 216.33, zloty 3.0238, koruna 20.087, RUB 32.6650, yen 104.74, sing 1.268, HKD 7.7549, INR 62.165, China 6.1156, pesos 13.0268, BRL 2.3565, Dollar Index 80.496, Oil $99.18, 10-year 2.98%, Silver $19.54, Platinum $1.342.50, Palladium $695.00, and Gold. $1,205.80

That's it for today.  A bit shorter than normal, and you can expect another short Pfennig tomorrow as there just isn't a whole lot to write about during these holidays.  We are pretty short staffed on the desk today, as Antione, Mike, Jennifer, and Chuck are all out.  But the call volumes have been way down, so hopefully we will be able to keep up.  We've seen some 'year-end' selling to book losses on precious metals offsetting gains which investors have in the equity markets, but other than that we have seen limited trading.  Got to get this out the door now, as I'm going to have to log into the phones today.  I hope everyone has a 'Tub Thumping' Thursday, and thanks to all of you for reading the Pfennig!

Chris Gaffney, CFA
Vice President
EverBank World Markets