In This Issue.

* Dollar rallies on budget deal…
* Mixed data in the US…
* Chuck shares his thoughts on the RBA…
* Goldman agrees with us…

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

Dollar rallies on retail sales and budget deal…

Good day. And welcome to Friday the 13th.  I'm not too terribly superstitious and I actually like the number 13 for some odd reason.  Perhaps it is because it was my son's football jersey number, and it was the name of one of my favorite 'clubs' during my college days.  So I am heading into this Friday the 13th with a positive attitude.  Chuck is also planning on having a fabulous Friday 13th as he is off 'shopping' with a few good friends today; a great way to begin his vacation.

The dollar certainly doesn't seem bothered by the fact that it is Friday the 13th as it has been on a two day rally which has pushed the dollar index up to trade at the highest level this week.  The big news in the markets overnight was the House approval of the bipartisan committee's $1.01 trillion budget agreement.  The deal will now go on to the Senate who will vote on it sometime next week.  Antione was nice enough to forward me a quick synopsis of the spending plan which 'moves' a big chunk of the sequester spending cuts planned for this year out another 10 years and also includes additional revenue from higher TSA fees and adjustments to the calculation of Federal pensions.  The deal definitely does not go far enough in attacking our budget deficits and growing debt, but in the words of the House Speaker it is a 'good start' and a 'move in the right direction'. 

The markets certainly like the deal, as it removes another potential land mine which was awaiting us early next year.  We still need the Senate's approval, and a debt ceiling agreement but the markets think this is pretty much a done deal now.  The currency markets are also moving higher on the retail sales numbers released yesterday here in the US.  Retail sales advanced .7% MOM in November with the less volatile Ex Auto number moving .4% higher.  Both figures beat economists' expectations and last month's figures were also revised higher.  These numbers carry a bit more importance than usual as consumer confidence was fragile going into the very important holiday shopping season.  But as Chuck mentioned the other day, US consumers seem to be settling back into their borrow and spend ways which is exactly what the administration wants to see. 

While consumers seem to be confident enough to borrow in order to get all of those gifts for their loved ones, this confidence may be short lived.  The weekly job numbers jumped back above the 300k level, leaping all the way up to 368k for the week ending Dec. 7.  This was well above the expected number of 320k and proves that last week's dramatic drop may have been a aberration.  Speaking of last week's job number, the figure was revised from 298k to 300k which is a small move in actual numbers but a big psychological figure.  The 298k number was touted by several economists as proof the labor market was definitely improving, as it was only the second time the weekly number had been below 300k since May of 2007.  But the revision has thrown a wet blanket over all of that rhetoric.  The labor market is still struggling to recover here in the US, and this week's jobs figures definitely suggest the FOMC will not taper during their meeting next week. 

In addition to the Retail Sales and weekly jobs numbers we also got a report which showed Business Inventories increased .7% during October, something which we had already known from the details of the preliminary GDP report.  The retail sales figures suggest at least some of this inventory is heading out the door, but the question is will sales be enough to offset the big inventory buildup we saw going into December. 

We will see the PPI figures this morning which are expected to show producer prices were mostly unchanged during November.  The  MOM figure is expected to be flat, with the YOY figure reflecting a .8% rise in prices.  Inflation still does not seem to be creeping back into the economy which is another reason I don't think the quantitative easing efforts of our FOMC will end any time soon.  I was speaking to a reporter yesterday morning and the conversation turned toward the taper, as it always seems to!  Economists have increased predictions of a December taper up to 34% from last week's 17% level. Pfennig readers know that neither Chuck nor I are expecting a taper this year, and not even during the first quarter of 2014.  I just don't think the data on the labor markets support a start to the end of the bond buying.  Not that I was ever a supporter of QE, and I would actually love to see the FOMC announce an end to their bond purchases but I just don't think the data which they have continued to point to support the thought that the taper will start next week.  I personally think the bond buying will continue until Bernanke steps away and the jobs data show that there is a consistent trend of improvement.  By the way, today is not only Friday the 13th but it is also the 60th birthday of our Fed Chair Ben Bernanke, I'm sure all the readers will want to wish our Fed Head a very happy birthday – you certainly should if you have any money invested in the US equity market!

The taper talk continues to dominate trader's thoughts, and the future direction of interest rates is one very important factor driving the currency markets during 2014. Overnight the Japanese yen fell to a five year low on yield differentials. Policy divergence between the BOJ and the FOMC was given as the main reason for the weaker yen. Currency investors seem convinced the FOMC will start to taper while at the same time the BOJ is planning to expand its asset purchase program.  The view that fiscal policy is moving in opposite directions seems to be a popular one as you will see in today's TTWT section.  Firms like Barclays, BNP Paribas, and Morgan Stanley all point to rising US rates in support of their calls for stronger US$ levels during 2014. 

At least one bank is more in line with Chuck and my thoughts, and it is a big one in the global financial markets!  Goldman Sachs' London based chief currency strategist said he expects the dollar will weaken through 2014, reaching $1.40 per euro.  This is in line with Chuck's thoughts as he agrees the euro will strengthen next year.  I agree with the consensus that the Fed will start to taper sometime in 2014, but any taper in bond buying will be offset by the Fed keeping interest rates near zero through the use of reverse repos and negative deposit rates.  At the same time, I don't think the ECB will be as aggressive with monetary stimulus as many of the other banks have predicted.  According to Goldman's strategist, “Tapering is in the price already, we find it difficult to see where the dollar strength would come from. There is always a risk that stronger growth in the US suddenly pushes rates even higher as markets anticipate a stronger Fed response.  However, our base case is that we see only marginal support for the dollar from interest rates.”  Chuck expressed similar thoughts yesterday when we were discussing the possibility of a December taper.  Any taper is already priced into the dollar and the markets, so when it occurs it shouldn't really have a dramatic impact. 

Chuck sent me his thoughts on the Aussie dollar on the way out the door yesterday, so I will share them with all of you.  Take it away Chuck:

Well, the Aussie dollar (A$) really got whacked yesterday after I signed off, and all the selling points back to an interview that Reserve Bank of Australia (RBA) Gov. Stevens had with the Australian Financial Review.  In the interview, Stevens really attacks the A$'s strength. He indicated that he wants an A$ closer to 85-cents, and called on the nation to face an urgent conversation about the spending cuts or tax reform that will be needed to return the federal budget to surplus.   These words spooked traders and investors to really unload A$'s, for if a Central Banker puts a figure/ level on a currency most likely he's going to guide the currency to that level.  Now, back in “the day” the markets would fight him on that, IF they thought he was wrong. But in today's world of Central Bank influence in the markets, that just doesn't happen any longer.

Yes, the markets have cowered to Central Bankers, I can't believe I'm saying that. But it's true, it's true, I did see a putty tat! Why has this changed? Because have you seen what the Fed has done to anyone who dared to fight their bond buying? They just kept adding to the programs, and extending the amounts, thus wiping out anyone that tried to sell short Treasuries, for they felt the Treasury Bubble had seen enough air blown into it.  So, now, the markets know all too well that they can't fight city hall any longer, for if the Central Bank needs deeper pockets, they simply turn on the printing presses.  

I'm going shopping later today, I'm going to have a lot of fun, and put all this talk of Tapering, Central Banks, Central Bankers, Bubbles and everything else in my rear view mirror. I suggest you do the same, for there's nothing we can do to change these things, only make moves to protect ourselves from the outcomes of all this meddling.  Now back to Chris!

It will be nice to be able to finally see an end to all of the 'taper talk' but unfortunately I don't think that is coming until next week.  All of the markets have been held hostage by the FOMC and their bond buying.  The big question is what happens if/when the bond buying stops. 

Then there was this. Our head currency trader, Jennifer sent me an excellent piece from her counterparts at Barclays sharing their thoughts on where the US$ is heading in 2014.  The title of the piece “More in store than USD strength” should give you an idea of their overall view which is basically the same as my own; that there will be opportunities in the currency markets during 2014.  Unfortunately I am unable to post the entire piece here (it is proprietary after all) but will share some of the highlights:  1. ECB will diverge from the FED – they believe the Fed will begin tightening while the ECB will continue to pursue looser monetary policies.  On this point I disagree, as I don't believe our new Fed chief will be eager to start tightening, and the ECB will not be eager to start throwing money at the markets (I expect them to continue to use words instead of euros).   2. JPY will continue weaker.  On this I agree.  3. GBP will continue to outperform.  I am non-committal on this one but tend to lean toward GBP weakness in 2014. 4. AUD will continue to fall while CNY will move higher.  I don't agree with the call for AUD but do agree the Chinese renminbi will continue to appreciate.  5. CHF will move lower.  This is in conjunction with their call for a weaker Euro and I disagree as I believe the Euro will see some strength in 2014. 6. EM currencies will be stronger in 2014.  On this point I heartily agree.  The emerging markets are beginning to see some strength again, and investors will turn back to the higher yielding currencies as the global economy improves.

To recap. The dollar is stronger after positive retail sales figures and a budget agreement was passed by the House.  Taper talk continues to dominate the news, with many now expecting a cut in the bond buying next week.  Most major banks are predicting further dollar strength in 2014 while Goldman Sachs is going against the crowd (along with Chuck).  The Aussie dollar takes a hit from Governor Stevens who successfully 'jawboned' it lower.  And I shared some of Barclay's currency predictions for 2014.

Currencies today 12/13/13. American Style: A$ .8917, kiwi .8210, C$ .9380, euro 1.3716, sterling 1.6265, Swiss $1.1220. European Style: rand 10.3375, krone 6.2092, SEK 6.5908, forint 220.93, zloty 3.0486, koruna 20.066, RUB 32.86, yen 103.57, sing 1.2569, HKD 7.7530, INR 62.125, China 6.1148, pesos 12.9821, BRL 2.3322, Dollar Index 80.367, Oil $97.18, 10-year 2.88%, Silver $19.51, Platinum $1.364.99, Palladium $722.75, and Gold. $1,231.30

That's it for today. I had a great night as I got a last minute invite to watch the Blues who absolutely dominated the Toronto Maple Leafs. We are supposed to get some bad weather today, with a 'wintry mix' (two scary words during winter!) expected midday.  I've got a busy weekend planned with a high school hockey game tonight, my daughter's first high school swim meet tomorrow (good luck Lauren!), and the Rams game on Sunday.  And I'm going to try and squeeze in some duck hunting and Christmas shopping at some point which will definitely make it a full weekend.  Got to go now as it is Friday which means it is our 'weigh in' day on the desk.  Many of us on the desk are competing in a 'biggest loser' contest which is in its third week.  I am not expecting much this week as I weighed myself yesterday and I think I actually gained a pound.  Oh well, we still have a couple months left.  Hopefully everyone will have a Fantastic Friday the 13th and a wonderful weekend!  Thanks for reading the pfennig.

Chris Gaffney, CFA
Vice President
EverBank World Markets