In This Issue.

* Hump Daaaay for the FOMC …
* TIC flows show foreign investors shedding US Treasuries…
*  Loonie is the best performer vs. US$…
*  Renminbi set for a year-end rally???

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

Hump Daaaaay for the FOMC…

Good Day!  And what day is it?  Mike, Mike, Mike, Mike?  Hump Daaaaaaay…  That commercial is still one of my favorites, but I'm sure Mike is glad it is no longer on TV.  And this is not just 'another' Wednesday, as this is the day many investors have been anxiously awaiting.  This afternoon we will get to see what the members of the Federal Open Market Committee are predicting about the future path of the US economy and how quickly they think interest rates will be heading higher.  Will the members of the FOMC change course?  I have been reading a lot of different opinions on what the FOMC statement will say, and the 'no change' camp is gaining ground now that PIMCO's boss Bill Gross came out with his opinion that the statement will remain 'dovish'. 

Gross was  not alone in his opinion that the FOMC statement will be more dovish than investors had predicted, and the markets reacted quickly to the change in sentiment.  Yesterday morning the dollar continued to drift lower – tracking along the path which it had established on Monday; but around noon Mike Harrell shouted across the trading desk that things were getting a lot more volatile.  We scrambled to see what was causing the sudden drop in the US $ and discovered it was due to a combination of a Wall Street Journal report and the comments by Bill Gross.  Both had currency investors reversing their 'long dollar' positions as opinions were shifting and suddenly many felt the 'considerable time' wording may actually stay in the FOMC statement.    

Remember Chairman Yellen's 'goof' during her first press conference as the new leader of the Fed back in March?  Asked to elaborate on what the Fed governors meant by 'a considerable time' between the end of QE and the first interest rate rise, Yellen said “around 6 months”.  The markets immediately predicted interest rates would be increasing in April of 2015, since it was fairly certain that the bond buying would be ending in October of this year.  That date has largely remained the consensus bet with slight adjustments if/when the economic data showed the US economic recovery was accelerating or slowing.  But I continue to believe Yellen's remarks weren't really a goof but were instead an attempt by her to get the markets comfortable with the fact that interest rates are heading higher at some point in the future.  Whether that date is April, June, or December of next year really doesn't have as much of an impact as understanding that today's ultra-low rate environment won't last forever. 

Chairman Yellen will be taking another shot at trying to make sure investors understand rates are heading higher, but she will need to be VERY careful in her wording as she does not want to cause a knee-jerk reaction in the markets.  She will want to ease us into the rate hikes, avoiding any spike in interest rates which could smother the economic recovery.  Slow and steady will be her mantra, and that may mean leaving the 'considerable time' wording in – as we are still over 6 months away from the consensus estimate of the first rate rise anyway.

Yesterday I got so caught up in the FOMC meeting and discussing what could happen that I totally missed reporting on the data which was going to be released here in the US.  US Producer Prices were reported for August, and the data showed inflation (as reported by this piece of data) is still muted.  Prices at the factory level increased by .1% in August, in line with economist's expectations.  For the 12 months through August, producer prices increased 1.8% following a 1.7% increase in July. 

While the market will be focusing on the FOMC statement due out at 2 pm today, we will first see another round of CPI data for the month of August.  Expectations by economists peg the yearly increase in consumer prices at 1.9% with no increase for the month of August.  Definitely benign inflation data which will continue to keep the Fed's focus on the weakness in the labor market instead of worries about stoking future inflation.  This data is the main reason the FOMC has been able to keep rates so accommodative, and if the CPI data comes in as expected it is not out of the question that Yellen will keep interest rates at their current levels for a  'considerable time'.

We also got the Net Long-term TIC Flows for July.  Last month's data showed foreign investors pulled 18.7 billion out of the US financial system, and economists had expected to see a reversal of this in July.  Well the number which was released yesterday afternoon showed another $18.6 billion was removed from the US by foreign investors last month.  This was a big surprise to economists who had predicted an increase of $25 billion in TIC flows for July.  The data showed China's holdings of US Treasuries fell to $1.265 trillion in July as foreigners sold US Treasuries for a second consecutive month.  Chuck has been warning readers of the Pfennig about what would happen if/when foreign investors finally start to sell their US debt.  Foreign buying is what has helped keep our rates so low for so long, and these negative TIC flows at the same time QE is ending is something which I'm sure Chuck is watching and worrying about.  If foreign demand continues to wane rates could move higher much more quickly than anyone has predicted (including our own FOMC!).

And while I'm on China, the PBOC announced they would be pumping 500 billion renminbi ($81.4 billion) of liquidity into the country's five largest banks in order to try and stimulate the Chinese economy.  Premier Li Keqiang continues to look for ways to pump up the lagging growth rate in China, as the stated goal of 7.5% growth continues to come under pressure.  The half trillion renminbi is the equivalent of a 50 basis point reserve rate cut and with the 'control' the Chinese government excerpts over these state-owned banks the money will certainly be lent out quickly.  The move shows the Chinese government is worried their 7.5% GDP goal is at risk and is ready to take additional steps in order to stimulate the Chinese economy.

The pound sterling is recovering some of the losses which it booked following the poll numbers announced over the weekend.  It seems the latest polls on the Scottish independence vote show the NO votes are back in control.  But the vote is still much too close to call, and the lowering of the voting age to 16 has caused many to believe the polls may be underestimating the YES votes (the younger voters are overwhelmingly in favor of an independent Scotland).  The voting will occur tomorrow, giving me something besides the FOMC statement to talk about in tomorrow's Pfennig!

The Canadian dollar ended yesterday with the best 24 hour return of all of the major currencies.  The 'loonie' moved higher after data showed domestic factory sales rose more than expected in July.  Statistics Canada reported that manufacturing sales rose 2.5% in July, more than double the figure economists had predicted.   BOC Governor Stephen Poloz added fuel to the loonie's rise by focusing attention on a recent rise in exports which he called the “natural engine of growth.”  “We are cautiously optimistic about our exporting future.” Poloz said today during a speech in Quebec. While cautioning that it will take some time, ” it looks like the natural sequence we've been hoping for is getting under way.”   The ongoing recovery here in the US is predicted to give a further boost to Canadian exports, but they will need an increase out of their neighbors to the south in order to offset the expected drop in exports to a slumping Europe.

During today's speech, Governor Poloz also tried to downplay any plans to 'control' the Canadian currency.  “Trying to control the loonie is off the table.  A floating loon is a thing of beauty, and so is a floating loonie.”  A fairly colorful line by Poloz who has seen the value of the Canadian currency drop by over 7 percent since he took the reins from current BOE Governor Mark Carney. 

One central bank which is not opposed to controlling their currency is the Swiss National Bank which pegged their franc to the Euro three years ago.  The SNB hasn't had to defend the 1.20 cap on the CHF/EUR exchange rate over the past two years as the euro has steadily increased in value.  But the recent drop in the value of the euro has the franc testing the limit set by the SNB.   Many believe the SNB will probably have to begin selling the CHF vs. the euro or match the ECB's negative deposit rates in order to maintain the 1.20 peg.   SNB President Thomas Jordan has said he is ready to wage 'unlimited' currency interventions' to protect the peg. 

For What it's Worth.   Another central bank who continues to control their currency is the PBOC who has continued to 'control' the Chinese Renminbi ever since letting it float within a trading band back in 2005.  I am a regular reader of the Institutional Investor magazine and came across a story on the website which I thought would interest our readers.  The story, written by Hayden Briscoe of AllianceBernstein lays out Mr. Briscoe's case for a  year-end  rally in the price of the Chinese Renminbi.  Mr. Briscoe points to the past history of the  PBOC in allowing the currency to depreciate in front of a widening of the trading ban.  Here are some highlights from the article which you can read in full at the following:

The decision by the People's Bank of China (PBOC) early this year to weaken the renminbi came as a shock to many investors who expected the currency to maintain a long-term path of appreciation.  After all, the renminbi had been strengthening against the U.S. dollar for nine years, and its trajectory was consistent with the government's stated aim of internationalizing the currency.

For close observers, however, the move wasn't unprecendented or necessarily at odds with Chinese policy.  The PBOC had made a similar move in mid-2012, lowering the rate at which the renminbi was fixed each day against the dollar.  A six-month period of slight depreciation followed; during that time, the PBOC widened the band around the fix in which the renminbi could trade.  Eventually, the currency resumed its upward climb…

…we regard the renminbi's depreciation year to date as finite and implying a likely recovery, rather than further weakness.  If one believes – as, in our view, the evidence suggests – that China hasn't changed its stance on the currency, then the renminbi's performance on a rolling 12-month daily basis should be flat to positive.  If that's the case, this year's depreciation has reached a point relative to last year's performance, illustrated by the blue line in the chart, at which the daily fix may strengthen, reversing the recent trend.  This would enable the renminbi to resume its steady appreciation on a rolling 12-month daily basis and keep the positive currency policy intact.

In other words, the PBOC's desire to maintain an appreciating currency is likely to result in an end-of-year rally in the renminbi.

To recap.  The FOMC will end their two day meeting and release their statement, but the question remains regarding the 'considerable time' wording.  The dollar had a fairly sharp drop after the WSJ and Bill Gross came out predicting a more dovish statement.  Data released yesterday showed inflation continues to be muted, and foreign investors sold their US Treasuries for a second consecutive month.  The Canadian dollar was the best performing currency after data showed manufacturing sales rose.  And I ended today's Pfennig with highlights from an article making the case for a year-end rally for the Chinese currency.

Currencies today 9/17/14. American Style: A$ .9056, kiwi .8169, C$ .9112, euro 1.2959, sterling 1.6323, Swiss $1.0710. European Style: rand 10.9420, krone 6.4097, SEK 7.1466, forint 241.95, zloty 3.2328, koruna 21.244, RUB 38.358, yen 107.32, sing 1.2636, HKD 7.7507, INR 60.875, China 6.1450, pesos 13.1811, BRL 2.3364, Dollar Index 84.089, Oil $94.60, 10-year 2.57%, Silver $18.60, Platinum $1,356.90, Palladium $836.80, and Gold. $1,235.64

That's it for today.  The beautiful fall weather continues to take hold here in the Midwest.  Fall is by far my favorite season, as I enjoy the crisp morning runs and sitting out on my deck in the evenings.  I have a busy day today, with several interviews lined up with reporters who want to get my views on the FOMC statement.  It should certainly be an interesting day in the markets!  With that I will hit the send button.  I hope you have a Wonderful Wednesday and thanks again for reading the Pfennig.

Chris Gaffney, CFA
Vice President
EverBank World Markets