In This Issue.

*TIC Flows indicate a loss of confidence…
*Yen falls as Abe pushes for more stimulus…
* China growth forecasts increased…
*Sweden’s Riksbank cuts rates…

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

International investors begin to move away from the US$…

Good day. I made it through a busy Monday yesterday as we deal with being a few people short on the desk this week.  The phones were busy as they typically are on a Monday morning, and Mike mentioned that there must have been a full moon as we dealt with some unusual customer requests.  It certainly made for a wild and wacky Monday.  In contrast, the markets are already on holiday, and the currencies were basically unchanged on the day.

The only news driving the markets yesterday were details leaked from another round negotiations in the fiscal cliff.  The President has now agreed to raise the cutoff for tax increases from 250k to 400k while House Speaker John Boehner was rumored to have agreed to an automatic extension of the federal debt limit and an increase of taxes on those making over a $1M.  But these concessions still don’t seem to have moved us any closer to a resolution as there will now need to be agreements on the more difficult area of spending cuts / reductions.  Congress has agreed to remain in session until the end of the year, with only a short break for Christmas; so there is still a chance a deal is worked out prior to the end of the year.  As readers know, I believe there will be a deal struck, with some tax increases combined with a few spending cuts providing the leaders in Washington enough cover to ‘kick the can’ further down the road.  The whole point of this fiscal cliff was to force congress and the President into some meaningful actions on the rising debt and deficits, but it looks like they will instead figure out a way to wiggle their way out of the corner they painted themselves into. 

Data released yesterday showed a rather dramatic drop in the TIC flows during October.  For those new to class, the TIC flow number is a measurement of foreign buying of assets here in the US.  The Net Long Term TIC Flows were just $1.3 billion vs a projected $25 bilion of foreign purchases during the month of October.  The Total Net TIC Flows number was even more disturbing, showing a reduction of $56.7 billion in October as opposed to net purchases of $4.3 billion the previous month.  Foreign investors seem to be reducing their US equity and fixed income investments as the global economic picture seems to be improving.  I have discussed in depth how the flows into the US treasury market have been a temporary ‘liquidity’ shelter during the financial crisis in both Europe and the US.  The markets have been taking a breather from the earlier constant coverage of the European debt problems, and recent news out of China has bolstered confidence of a continued recovery in the Asian markets.  The Fiscal Cliff is the one remaining ‘hot spot’ and it now looks like international investors were starting to diversify back out of the dollar back in October.  This is the major concern which both Chuck and I have expressed, that a loss in international confidence in the US$ could quickly lead to major problems for the US.  As I wrote in Sunday’s Pfennig and Pfriends, the apparent ‘plan’ to deal with the debt crisis here in the US is to print our way out of it.  But this plan depends on the dollar remaining as the international reserve currency, and a loss of confidence by international investors could derail any hope of the US inflating our way out of trouble.

Chuck constantly reminds us that one month’s data does not make a trend, but yesterday’s TIC flows are definitely concerning and you can bet we will be keeping a very close watch on International sentiment regarding the US currency.  The other piece of data released yesterday was also troubling for the US as the Empire Manufacturing Index showed a drop of 8.1% in December compared to a decrease of 5.22% during the previous month.  Today we will get the Current Account Balance which is projected to show we ran a deficit of $103.5 billion during the 3rd quarter.  This would actually be an improvement from the previous estimates which indicated a deficit of $117.4 billion.  We will also get the NAHB Housing market index which is predicted to show a slight increase, though it is predicted to remain below 50 which indicates a contraction.

Moving into the foreign markets, the Japanese yen fell again as the newly elected Prime Minister Shinzo Abe continues to press BOJ policy makers to increase stimulus spending.  The yen is currently trading near a 2 year low vs. the US$ and has been the worst performing currency vs. the US$, losing over 3% vs. the US$ during the past 30 days.  Japan has been mired in a ‘lost decade’ or more appropriately ‘decades’ as leaders struggle to get the economy growing.  Japan has amassed record amounts of debt funding numerous attempts at quantitative easing.  But in spite having kept interest rates near zero for the past decade plus, the Japanese economy has failed to grow.  Abe is pushing the BOJ to try new methods to force inflation back into the Japanese economy, but unfortunately for him the Japanese consumers have continued to save instead of spend.  Without consumption, inflation has been held in check and the Japanese economy has failed to grow.  A stronger Japanese yen has added to the problems as it has been a drag on exports, further hampering the Japanese recovery efforts.  I just don’t see anything positive for the Japanese yen, and would suggest staying away from this Asian currency.

In my opinion, the Chinese Renminbi is a better currency choice for investors looking  to get some exposure to the Asian markets.  The People’s Bank of China raised the renminbi reference rate for a second day as a government report showed housing prices increased in 53 of the 70 major cities during the month of November.  The Goldman Sachs Group is confident the Chinese economy is on the right path and boosted its economic growth forecasts for the current quarter and 2013.  Goldman mentioned the recovery in manufacturing as a reason for their improved growth projections.  China has set its official target for economic growth at 7.5% for 2013, and tightened its inflation goal to 3.5%, the lowest level since 2010.  It certainly is an indication that the Chinese economy is maturing, and moving from a high growth/ high inflation emerging market to a slower growth / lower inflation one.

Chuck, Frank, and I sat around last Friday and recorded a few of our predictions for 2013 (to be used in a future Pfennig and Pfriends).  I pointed to the emergence of the ‘Chinese consumer’ as one of the driving forces in the global markets in 2013.  I know there is still a lot of poverty in China, as a majority of their population is still in rural areas.  But there has been a slow and steady increase in the disposable income for the average Chinese citizen. Even though the increase has been small, when you spread this across the massive population of China it can have a real impact on the global economy.  The Chinese economy will continue to ease toward a more consumer driven economy, and the emerging Chinese consumer should take up some of the slack left by slowdowns in both Europe and the US.

In Europe the Riksbank reduced its benchmark interest rate  for a fourth time in a year as the Nordic country continues to try and combat the slowdown caused by the European debt crisis.  The market still believes there is a chance of one more rate cut sometime early next year, even though the bank has signaled it will probably keep the benchmark rates unchanged until the end of next year.  The Euro-area recession has hurt exports from Sweden, and the Swedish economy is starting to show the impact of these lower exports and a strong krona.  Investors looking for an alternative to their Euro investments have pushed the Swedish krona up over 4% vs. the US$ during 2012.  In other rate news, Hungary’s central bank is expected to follow suit with a rate cut today.

The commodity currencies were up slightly yesterday with the Australian dollar extending its recent gains. Gold climbed from a one week low as optimism increased regarding a debt deal here in the US.  The shiny metal broke through the $1,700 level to reach $1,703 before retreating back during overnight trading.  Silver also climbed as did the price of crude.  It seems investor sentiment is improving, but the markets are very thin with nobody really wanting to take a large position this close to the end of the year. 

And then there was this. I am running a bit late this morning, so I asked Mike Meyer to come up with my TTWT this morning.  He found an interest article to share with all of you regarding the Fed’s new interest rate policy trigger.  According to an article in the Washington Post, the Fed could remain in a holding pattern for interest rates longer than some anticipate given the new ties to the employment market. “Over the past year, the U.S. unemployment rate has fallen rapidly, from 8.7 percent last November to 7.7 percent today. But a new paper from the Federal Reserve Bank of San Francisco suggests that this decline could soon stall out. Why is that? Not because the U.S. economy is about to slow down. Rather, it’s because a number of discouraged workers who had previously dropped out of the labor force may soon start searching for jobs again. That’s good news for the economy, but it means that the official unemployment rate could flat-line for a year or two – even if the economy’s improving. Remember, the official unemployment rate only measures people who are part of the “labor force”, that is, people who either have jobs or are actively looking for work. Since 2007, the U.S. labor force participation rate has shrunk dramatically.”

Remember what I said earlier about Japan being mired in a low interest rate no growth environment?  Sound familiar?  Interest rates here in the US are bound to stay near record low levels for an extended period, so investors need to figure ways to find some income outside of the traditional fixed income markets. 

To recap. The TIC flows indicate foreign investors may be growing tired of all of the debt debate and fiscal cliff negotiations, or maybe they are just gaining confidence in the global recovery.  Japan’s new Prime minister continues to push for more stimulus, driving the yen lower.  Chinese growth projections have increased.  Sweden’s central bank cut rates to try and reverse a slowdown caused by the Euro debt crisis.  And commodities were slightly improved in very thin markets.

Currencies today 12/18/12. American Style: A$ $1.0530, kiwi .8417, C$ $1.0158, euro 1.3184, sterling 1.6216, Swiss $1.0915. European Style: rand 8.5623, krone 5.5997, SEK 6.6271, forint 218.54, zloty 3.1038, koruna 19.1205, RUB 30.8692, JPY 83.89, SGD 1.2187, HKD 7.7501, INR 54.865, China 6.2325, pesos 12.7209, BRL 2.0948, Dollar Index 79.48, Oil $87.72, 10-year 1.77%, Silver $32.405, Gold $1,698.15, and Platinum $1612.00.

That’s it for today. I am running later than usual today, so I will keep the ‘closing paragraph’ short and sweet.  Things are definitely heating up here on the desk, not because the markets are moving, but because we are a bit short due to all of the holiday vacations.  I am staying in town for the holidays this year, so you are stuck with me through New Years.  Hope everyone has a Terrific Tuesday, and thanks for reading the Pfennig!

Chris Gaffney, CFA
Vice President
EverBank World Markets