Confidence in the EU Helps Rally the Markets

Good day… Chuck felt it was best to sit out one more day as he tries to recover from a major cold he came down with late last week. He wanted me to share a few of his thoughts with the Pfennig readers this morning, so I’ll start right off with them. Take it away Chuck…

Here are some observations from the cheap seats, where I sit on I.R.

Reading Chris’s take on the Black Friday numbers really got me thinking yesterday. I understand discounts, supply & demand, and good business. What I don’t understand is why a store/franchise decides, on this one day each year, to sell things at deep discounts, probably even having loss leaders. Why not sell the items at that price every day? Oh, I know the answer… It’s one of those rhetorical questions. But sometimes it’s interesting to hear the answers anyway! Oh well. I’ll make a bet here. I’ll bet a dollar to a Krispy Kreme that when all the dust settles on the holiday shopping, the euphoria that swelled from the announcement of Friday’s numbers, will bomb out.

There was good news from Australia last night. The ratings agency Fitch, upgraded — that’s right, I said upgraded — Australia’s long term local currency Issuer Default rating, which reflects the country’s fundamental credit strength, it’s economy, political situation, and monetary policies. The rating was upgraded from AA+ to AAA! Good show!

Gold sure liked the news that consumers in the US were supposedly back in the saddle. For, if the consumers are spending again, then inflation is soon to follow. I read yesterday between naps, that the amount of demand outweighed the amount of supply that was mined this year. Well, like I used to say in my presentations… The problem with mining gold (and silver) is that a miner just can’t flip a switch, and have gold appear! And I’ve questioned the weakness of gold the past couple of weeks, due to this demand. We see it firsthand here on our trading desk, folks. The demand for gold and silver remains very, very strong.

Thanks to Chuck for sharing his thought, this morning, and I know I speak for all of the Pfennig readers in wishing him a quick recovery.

The currencies enjoyed another good day versus the US dollar on Monday as investors seemed convinced that the Europeans would end up working things out. I wrote about the efforts to reach a more perfect fiscal union in Europe, and Germany’s finance minister encouraged a more stringent adherence to the budget discipline laid out in the EU treaty. But as I pointed out yesterday morning, even Germany isn’t currently adhering to the fiscal requirements laid out in the Maastrict treaty, so do you really think Italy, Greece, and Spain are going to make the sacrifices to get in line?

Not to get side tracked, but I had a reader ask a great question yesterday. He wanted to know what the debt-to-GDP ratio of the US is compared to those in Europe. According to the folks over at US News, the United States currently has a ratio of 92.7%, slightly higher than that of Germany (82.4%) and France (84.7%). Others of note: Canada (81.7%), Japan (225.9%), UK (76.7%), Brazil (66.8%), and China (19.1%). Pretty interesting stuff, but I told you I wouldn’t get sidetracked, so back to what is going on in the markets…

The euro was given an additional boost after Italy sold 7.5 billion euros of government bonds at auction this morning. Italy sold debt with maturities ranging from 2014 through 2022 and the auctions met with sufficient demand to keep rates in an acceptable range. This successful auction was a big relief for the folks over at the ECB who were pretty worried they would have to intervene after the failed auction in Germany last week.

Investors were looking for a reason to move back out of dollars, and all the talk of a new fiscal union in Europe gave them the perfect opportunity. With confidence on the rise, investors began to look at countries that will benefit from an economic expansion. The commodity currencies of Australia, Brazil, New Zealand, and South Africa were the biggest gainers on the day moving another 2% higher versus the US dollar.

The Australian dollar (AUD) was the best performer versus the greenback for a second straight day. As Chuck pointed out, the Aussie dollar was helped by the ratings upgrade by Fitch. But not all of the news out of Australia was good. The Australian Financial Review reported that the government will announce a cut of A$20 billion in revenue forecasts over the next four years. The global economic slowdown is the reason for the lower projections. New Zealand finance minister Bill English is indicating their monetary policies will closely follow those of their neighbors across the Tasman Sea. English said interest rate decisions will be influenced by a shift in Australia’s monetary stance, indicating that rates will remain at current levels for an extended period. The kiwi (NZD) continued to build on the momentum it had from the landslide re-election of the Prime Minister over the weekend.

The Brazilian real (BRL) rose the most in a month as investors came looking for yield. The real had lost over 5.6% last week, as investors fled back to the US treasuries on worries that Europe was heading for another major crisis.

While the ratings agencies were showing some love for the Aussie dollar, they weren’t so infatuated with the US. Fitch Ratings lowered their outlook for the US from stable to negative, matching the outlook of both of the other major rating agencies. Fitch still gives the US its top AAA rating, but they cut their outlook due to “declining confidence that timely fiscal measures necessary to place US public finances on a sustainable path will be forthcoming”. Fitch just couldn’t remain the only one with a stable outlook after the congressional ‘Super Committee’ failed to agree to deficit cuts. The rating agency now places the probability of a downgrade to US public finances at greater than 50 percent. Both Moody’s and S&P haven’t adjusted their ratings after the Super Committee failure, citing the automatic $1.2 trillion in spending cuts which will be triggered. I guess the rating agencies haven’t been listening to all of the talk out of Washington regarding how congress can sidestep these automatic cuts.

The data front was fairly quiet to start the week off here in the US, with New Home Sales increasing slightly less than expected but showing a bigger MOM percentage gain after September’s numbers were revised lower. A large supply of distressed properties in the foreclosure pipeline is what is being blamed for the drop in new home sales. Today we will see more data regarding the US housing market with the release of the S&P/Case Shiller Home price index along with a reading of Consumer Confidence for November. Home prices are expected to continue to tumble but are now falling at a slower rate, and consumer confidence is expected to have risen slightly (as is evident by the crowds of shoppers last weekend). As readers know, I am not one to believe consumer confidence will remain high through the holiday season, as 9% unemployment will continue to weigh on spending.

But global investors were feeling good yesterday and started hunting for investments which can pay a bit more interest than what they are getting in US Treasuries. With the move back into higher yielding currencies, investors left the ‘safe haven’ of the Japanese yen (JPY). The Japanese yen is still considered by many investors to be a safe haven and has appreciated 4.32% this year, making it the best performing currency versus the US dollar. But data released yesterday puts a bit of a question mark on Japan’s safe haven status. Japan’s central bank (The Bank of Japan) currently has its lowest capital ratio since fiscal 1979. The ratio fell to 7.23% at the end of September after the BOJ booked 92 billion yen in losses on foreign currency assets. This is the cost of intervention, as the BOJ has been selling yen while the markets are buying.

But investors have started moving out of the yen, pushing it lower versus most of the other major currencies, including the dollar. The most recent move has some analysts believing that the yen will weaken even further and the Japanese economy is continuing to stagnate. Japan’s jobless rate surged to 4.5% in October from 4.1% the previous month. That exceeded the median estimate of 4.2% and was the highest level in three months.

Then there was this… I came across a story on Bloomberg last night that jumped off the screen. The title of the article is “Secret Fed Loans Helped Banks Net $13B”. During the financial crisis of 2008 the Fed encouraged banks to borrow at below market interest rates in order to try and pump additional liquidity into the markets. Some of these banks needed the extra funding, while others simply took advantage of the ‘once in a lifetime’ opportunity to book some nice gains using the cheap money. The Fed wanted to keep the list of banks secret, but Bloomberg LP sued to get the details into the open. Here are a few paragraphs from the article:

The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in US history a secret. Now, the rest of the world can see what it was missing.

The Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day. Bankers didn’t mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy. And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed’s below-market rates, Bloomberg Markets magazine reports in its January issue.

The amount of money the central bank parceled out was surprising even to Gary H. Stern, president of the Federal Reserve Bank of Minneapolis from 1985 to 2009, who says he “wasn’t aware of the magnitude.” It dwarfed the Treasury Department’s better-known $700 billion Troubled Asset Relief Program, or TARP. Add up guarantees and lending limits, and the Fed had committed $7.77 trillion as of March 2009 to rescuing the financial system, more than half the value of everything produced in the US that year.

“TARP at least had some strings attached,” says Brad Miller, a North Carolina Democrat on the House Financial Services Committee, referring to the program’s executive-pay ceiling. “With the Fed programs, there was nothing.”

You can read the entire article here.

To recap… The feel good story of a new fiscal union in Europe continued to rally the euro, and caused global investors to regain some confidence. Chuck shared his views on the Black Friday shoppers and what he sees as a good supply/demand curve for precious metals. The commodity currencies are the big winners over the past two days, gaining back some of the losses they took last week. The Japanese yen got sold as investors exited safe havens, and a higher-than-expected unemployment rate in Japan didn’t help. And finally, Bloomberg has dug into all of the money the Fed offered up to the major banks, and the results of their investigative work are pretty interesting.

Chris Gaffney
for The Daily Reckoning