In This Issue.

* Yellen has something for everyone…
* Data shows risks of deflation still exist…
* Sterling pushes higher ahead of Scottish vote…
* Norway's central bank gives us hope…

And Now. Today's A Pfennig For Your Thoughts.

FOMC statement gives the markets what they want…

Good Day!  And welcome to Thursday.  The much awaited FOMC September meeting came to a close yesterday, and Chairman Yellen tried her best to give the markets what they wanted.  The dollar and US equities climbed to record highs while the bond market and precious metals sold off.  Today could turn out to be a historic one as many of the Scotts have already cast their vote for or against independence.  The results of this vote could have major implications not only on the UK, but across the globe.   Unfortunately we won't see any results from the vote until tomorrow morning, so the markets will continue to trade on yesterday's FOMC decision and today's data which includes the weekly jobs numbers along with some housing data.

Yesterday morning started with a surprisingly weak CPI reading here in the US.  US consumer prices fell for the first time in nearly 1 1/2 years in August, dropping .2% after a modest .1% increase in the previous month.  Expectations were for a flat MOM number due to falling gas prices, but the negative number surprised most market watchers.  This set up the FOMC announcement, which saw sentiment shift yesterday afternoon from expecting a change in the language to a common thought that the 'considerable time' qualifier would stay in the FOMC statement.

The theory is that without inflation pressures, there is no reason for the Federal Open Markets Committee to start to raise rates.  We always get a number of readers who point out the fact that inflation is alive and well in the US – just look at the shrinking size of goods, or increases in health care, education and food.  But the 'official' numbers don't reflect the reality; and the FOMC members use these official numbers to make their decisions so we have to pay attention to them in order to try read what the markets will do.  The Year on Year numbers did show a slight increase in the CPI during August but the 1.7% reading was the smallest YOY increase in five months. 

Janet Yellen has pointed to the labor markets as the key to when the FOMC will begin to increase rates, and yesterday she re-iterated her views that there are many different data points which are involved in judging the health of labor.  Average Hourly Earnings is one of these pieces of the puzzle and yesterday's data showed earnings increased .4% in August a number which matches the yearly increase.  This morning we are expected to see another week of over 300,000 initial jobless claims – another sign that there is still slack in the labor markets.  We will also get a look at housing starts and building permits in August, both of which are expected to show decreases in their MoM figures.  The inflation numbers released this week along with some of the recent data on labor and housing indicate that concerns about deflation risks are still somewhat valid.  And without inflationary pressures, there is little to force action by the FOMC.

And from my reading of our Fed Chairman, there will need to be a good reason in order for her to risk the fragile US recovery with an early increase in interest rates.  Janet Yellen has always been known to be a dove, and nothing I read or heard yesterday leads me to believe she has become any more hawkish during her short tenure at the helm of the Fed. 

So you are probably asking yourself 'so why did the currency and commodity markets sell off so sharply if the language of the Fed statement was largely unchanged'?  The answer is in the accompanying estimates of where interest rates will be in the coming years.  All of the voting members give their predictions of interest rates, inflation rates, and growth through 2017.  All of this data is plotted on a 'dot graph' so that their estimates can remain anonymous and the averages of these estimates accompany the FOMC statement.  Four of the 17 participants saw the fed funds rising to at least 4% at the end of 2017 and another six see it resting between 3.5% and 4%.  But the numbers which seemed to drive currency and metals investors were the interest rate estimates for the end of 2015.    For the end of next year, the median projection was 1.375% compared to a 1.125% estimate in June.  So while interest rates may not start rising any sooner than previously thought, the increases once they begin are expected to come a bit faster.

The higher interest rates were what the dollar bulls focused on, and the dollar index rallied to a 14 month high.  Jack Stapleton shouted across the floor from the Infinity desk to let me know the yen had hit a six year low vs. the US$ after the FOMC announcement.  The yen hit 108.10 yesterday and continued to weaken overnight in the Asian markets.   The emerging market currencies were some of the hardest hit following the FOMC meeting as investors worried US interest rates would rise more rapidly than previously predicted.  Many of these emerging markets attract investment dollars with positive interest rate differentials, so any indication that these differentials could narrow is bad news for these high yielding currencies.  The Brazilian real and Russian Ruble were two of the worst performing currencies as the rate differentials added to already negative sentiment. 

The South African rand is another 'high yielder' which came under selling pressure yesterday, but data showing consumer inflation rose to 6.4% YoY and retail sales increased 2.4% placed a floor under the currency.  The latest inflation data could convince the South African Reserve Bank to hike interest rates for a third time this year.  But trading in the rand was pretty volatile as investors weighed the possibility of a hike by the SAR against the increased expectations of faster rate increases here in the US.  The Scottish vote added to investor uncertainty in what turned into a 'risk off' day.

Speaking of the Scottish vote, the latest polls show the independence vote is absolutely too close to call.  The wild card in the voting is the addition of 16 and 17 year olds who are overwhelmingly in favor of independence.  The pound sterling gained vs. most of the major currencies yesterday, supported by the minutes of the last BOE policy meeting which showed two members had voted to raise interest rates.  But the sterling saw some additional selling pressure early this morning after data showed British retail sales grew slightly less than expected in August.  For the year, retail sales were up 3.9% last month, just shy of the forecast number of 4.1%.  I won't spend too much time on the pound as I'm sure Mike Meyer will bring you plenty of news from the UK tomorrow morning.

The best performing currency overnight was the Norwegian Krone which is up over 1.35% vs. the US$.  The rally by the krone came after Norway's central bank gave 'positive rate guidance' following their meeting today.  The Norges Bank kept the benchmark rate unchanged, but said it will start raising rates after 2015.  The bank also dropped a reference that it could cut rates this year and signaled a small chance for an increase in the first quarter of 2016. “The analyses in the monetary policy report presented today imply that the key policy rate will remain at the present level to the end of 2015, rising gradually thereafter,” Governor Oeystein Olsen said.  Olsen had 'jawboned' the currency lower during last June suggesting he may have to cut rates; and today he said that the krone weakening had been a 'positive element' for the economy as it helped push inflation closer to target. 

For What it's Worth.  Remember not too long ago when all the press was talking about the 'new currency wars'?  While there are a number of central banks still doing their best to 'control' their currencies (usually to the down side) the press has moved on and I haven't read much about their attempts at currency devaluation.  Yesterday as I was scanning the newswires for Pfennig Pfodder, I came across an interesting article on Reuters which called attention to the fact that the ECB has been using verbal currency intervention to force the value of the euro lower, without catching the attention of most journalists.  As usual, I'll share what I consider the highlights, but encourage you to read the full article at :

(Reuters) – Attempts by the European Central Bank to weaken the euro have the potential to spark a currency war but policymakers across the world are keeping silent, knowing the ECB has scant alternatives to keep its economy afloat.

Euro zone central bankers have spelled out the need for a weaker euro to breathe life into the bloc's economy, which flatlined in the second quarter and is flirting with deflation.

Such comments are usually a no-go among the big industrialised nations for fear that one country's bid to become more competitive might trigger a race to devalue currencies and prompt other economies to resort to protectionism.

But ECB measures that have helped push down the euro to below $1.30 from just shy of $1.40 in May have drawn little objection. These include verbal interventions, cutting interest rates close to zero and a pledge to flood the banking system with money via cheap loans and purchases of private sector debt.

… Although ECB chief Mario Draghi's initial efforts to talk down the euro raised eyebrows in Tokyo, policymakers there have been silent on recent verbal interventions by ECB officials.

After nearly two decades of deflation and economic stagnation – and with the yen at a six-year low against the dollar helping Japan's export-reliant economy – they know how important the currency channel can be.

When the Bank of Japan launched its massive quantitative easing (QE) programme in April last year, a tumbling yen was regarded as a key transmission mechanism, driving up import costs and salaries at exporters. That helped push core consumer inflation to above 1 percent from below zero in a year.

…Provided the ECB sticks to domestic assets and does not intervene directly – neither of which are on its agenda at present – its central bank peers are likely to tolerate its actions unless the euro takes a dramatic dive.

“Continuing to take steps to actively push down the exchange rate after the euro has fallen by, say, 30 percent would be enough to excite foreign critics,” Eichengreen said.

“But the euro's fall to date is only 5 percent on a trade-weighted basis. So any red line is far off in the future.”

To recap.  The FOMC meeting ended and the different market participants focused on different areas of the statement.  Equity investors were encouraged by the remaining 'considerable time' language while dollar bulls and the fixed income market focused on higher interest rate projections for the end of next year.  The dollar rose to a 6 year high vs. the yen and was up against all of the majors.  Emerging market currencies were some of the biggest losers as interest rate differentials are expected to narrow.  Scotts headed to the polls today, and the possibility of Scottish independence weighed on the pound along with a slightly disappointing retail sales number.  The best performing currency was a bit of a surprise with the Norwegian krone moving up over 1% vs. the US$ on rate hike hopes. 

Currencies today 9/18/14. American Style: A$ .8942, kiwi .8105, C$ .9091, euro 1.2870, sterling 1.6323, Swiss $1.0653. European Style: rand 11.0415, krone 6.3606, SEK 7.1398, forint 242.41, zloty 3.2574, koruna 21.369, RUB 38.45, yen 108.81, sing 1.2687, HKD 7.7512, INR 60.965, China 6.149, pesos 13.2531, BRL 2.3738, Dollar Index 84.602, Oil $94.16, 10-year 2.62%, Silver $18.37, Platinum $1,339.99, Palladium $821.22, and Gold. $1,218.66

That's it for today.   I stayed up to watch a terrific win by the 1st place Cardinals who rode on the back of their ace pitcher Adam Wainwright who pitched a complete game shutout.  Our magic number is now in single digits.  I am heading out the door shortly to head over to Richmond VA to visit my son.  It is parents weekend and both Tina and I are excited to get to see him even though it has only been a month.  We will get to watch him play in his second hockey game of the season which should be fun.  They lost their first game but Brendan picked up an assist which had him pretty pumped up.  Mike will bring you tomorrow's Pfennig, and some big news so make sure you stay tuned!  Have a great Thursday and thanks for reading the Pfennig!

Chris Gaffney, CFA
Vice President
EverBank World Markets