Kim Jong Il's Death Sends a Shiver Across the Markets

The markets are starting off the week on a bad note, as the death of North Korea’s ‘Dear Leader’ Kim Jong Il has investors moving back into safe havens. North Korean state television announced that the leader had died of a heart attack, spurring concern that a nuclear armed nation is without a leader. The government called on North Koreans to ‘loyally follow’ Kim Jong Un, one of Kim Jong Il’s sons. The South Korean won tumbled over 5% after the news, but seems to have hit a bottom in early European trading. Most of the other major currencies are also down a bit versus the US dollar which is still seen as the best safe haven.

So the dollar is seeing some buying this morning which has offset some of the selling which occurred on Friday. Economic data releases at the end of last week had many investors wading back into riskier assets, as there was some confidence the US would be able to muddle through at a slightly faster pace. The cost of living in the US was little changed in November according to the CPI data which was released Friday. Consumer Prices were flat MOM in November and had a 3.4% increase compared with a year ago. This data supports the Federal Reserve’s view that inflation will remain in check, and will allow rates in the US to remain near zero for an extended period.

This will be a much slower week for data releases, here in the US, with only housing data released tomorrow and Wednesday. Thursday will be the busiest data day with the release of 3Q GDP, Personal consumption, Leading indicators, and the weekly jobs numbers. Friday will end the week with the release of durable goods orders for November along with Personal Income and Spending levels for last month.

The death of North Korea’s leader pushed news of the European debt crisis off of the front pages of the Bloomberg this morning, but the Eurozone crisis is still the dominant story of the currency markets. The euro (EUR) held in a fairly tight range on Friday, closing just slightly higher than where it opened against the US dollar. The euro dropped a bit in Asian trading this weekend but has gained back these losses since Europe opened up. The rating agencies jumped back into the fray with Fitch revising its outlook on the ratings of Belgium, Spain, Slovenia, Italy, Ireland and Cyprus to negative and said France is more exposed to the crisis than other top-rated Eurozone countries. Moody’s also weighed in, downgrading Belgium’s sovereign debt rating by two steps, to Aa3. But the markets continue to be a bit ahead of the rating agencies, so the revised outlooks didn’t have a major impact on the common currency.

Spain’s new Prime Minister Mariano Rajoy will take office later this week. Rajoy was defeated by the socialists back in 2004, but won the job back after promising to cut Spain’s budget deficits and regain investor confidence. The new Prime Minister will have to balance spending cuts with Spain’s fragile economic recovery.

And if PM Rajoy can institute major spending cuts he will become popular with ECB President Mario Draghi. Draghi said there is no ‘external savior’ for countries that don’t implement structural reforms to restore confidence to debt markets. “There is no external savior for a country that doesn’t want to save itself,” Draghi said in a speech in Berlin. Many economists want the ECB to step up bond buying in order to stabilize yields which continue to edge higher. But Draghi is resisting these calls for additional bond buying, focusing instead on making sure European banks have enough liquidity to prevent another credit freeze. Draghi obviously feels that direct purchases of sovereign debt by the ECB is not what the ECB should be doing. “People have to accept that we have to, and always will, act in accordance with our mandate and within our legal foundations,” Draghi told The Financial Times in an interview, confirmed by the Frankfurt-based ECB. “The important thing is to restore the trust of the people — citizens as well as investors — in our continent. We won’t achieve that by destroying the credibility of the ECB.” Much of that credibility has already been destroyed, and Draghi apparently wants to try and hold on to what is left.

French President Nicolas Sarkozy is in the other camp and is one of the most vocal leaders pushing for more direct bond buying by the ECB. The ECB has offered unlimited funding to banks with the hope that these banks will use the funds to purchase the sovereign debt. But many of these European banks have already booked large losses on debt which they own, and purchasing more doesn’t seem very popular right now. That is the problem countries like Spain and Italy face as they hold more debt auctions this week. The banks just don’t want to buy more debt, and the ECB isn’t wanting to step into the auctions either. It will be interesting to see if the void can be filled by individual and institutional investors, and what yield these buyers will demand.

The debt problems in Europe certainly look like they are going to continue to dominate the news and will also continue to weigh on the value of the euro. Commerzbank, one of the largest German banks, believes the euro is headed toward $1.20 next year, and suggests investors should sell the currency on any rallies. “The market has broken down through its 2011 uptrend and is now focused on the 2011 low of $1.2860,” Commerzbank technical analysts wrote in a research report today.

Friday I read where another big investor is negative on the euro. John Taylor, founder of the world’s largest currency hedge fund, says the euro will send to parity against the dollar. “It should be lower than it is,” Taylor said in an interview on Friday. “It’s a distinct possibility that the euro could weaken to trade on a one to one basis with its US counterpart in the next 18 months.” Back in January Taylor said the euro was going to fall below parity in 2011, so he has been a euro bear for some time.

The euro has been amazingly resilient in the face of all of the negative news from the debt crisis. The euro is currently trading at 8.3% above the average since it began trading in 1999. Probably a sign that investors just don’t have a good alternative.

Chuck is taking some time off of the desk, but is still keeping up on the news of the currency markets and sent me his thoughts on things late last night:

So… Here goes… I’m sitting here tonight, and reading things about Europe… It’s “Europe this”, “Europe that”, “they can’t make it” and so on… But where’s the “US this”, and “US that”, and “how are we going to make it”? You have to be a real sleuth to find stuff like that (other than right here in the Pfennig, of course!) Because, I’ve always been an Aaron Neville king of guy, and tell it like it is… Don’t be afraid, to let your conscience be your guide…

The Big Boss, Frank Trotter shows a slide during some of his presentations that goes through the statistics for US population, investable worth, and all that, and then shocks the audience by showing them that the MEDIAN investable worth in the US is about $8,000… I was reminded of this slide and presentation by Frank, when I read this piece of data tonight…

The retirement crisis in the United States just continues to get worse. According to the Employee Benefit Research Institute, 46 percent of all American workers have less than $10,000 saved for retirement, and 29 percent of all American workers have less than $1,000 saved for retirement.

So… It’s quite obvious that the US can’t depend on its taxpayers to bail the government out of this debt mess… That’s why the government has to depend on the kindness of strangers… Foreign investment… Or to put it simply, buying our debt, which is represented by US Treasuries…. The people running the government don’t believe that they have to reduce the deficit spending, for to them, “the foreigners always show up to buy our debt”… Well… As I showed on Friday last week, the Chinese are reducing their appetite for our debt… Slowly… Think about that for a minute… It’s the old frog in the boiling pot of water explanation… If you put the frog in a boiling pot of water, the frog will immediately jump out… But if you put him in the pot of water and slowly turn the heat up a little at a time, before the frog realizes the water is too hot, he’s cooked!

Well… Before the US government realizes that the foreigners have been slowly reducing their appetite for Treasuries, the US government will be cooked! And when that happens, folks… All the people who laughed at me 10 years ago (and counting)… All the people who said the US would never have to worry about foreigners buying our debt… All the people who thought investing in currencies and metals was “unpatriotic”… They’ll also be cooked!

Thanks again to Chuck for sending me his thoughts to include in the Pfennig. Chuck just can’t take a vacation from the markets!

The European crisis is sending ripples across the continent. Sweden’s Riksbank is expected to cut rates for the first time since 2009 as the largest Nordic economy feels the impact of Europe’s debt crisis. Most economists are predicting a 0.25% cut in rates, but some believe the Riksbank will make a more dramatic 0.50% rate cut.

Swiss economic growth is predicted to grind to a halt next year and is expected to grow just 1.9% in 2013 according to the KOF Economic Institute. SNB President Phillip Hildebrand will be meeting with the government today and will undoubtedly discuss his efforts to peg the Swiss franc (CHF) to the euro. The Swiss franc will end the year basically flat versus the US dollar as the large gains of the first half of the year were offset by the SNB’s fixing of the franc to the euro.

The Aussie dollar (AUD) and New Zealand dollar (NZD) both rallied on Friday as investors felt more confident regarding the global economic recovery. But these small gains were erased in early trading today as the news of the death of North Korea’s leader has shaken the markets.

Silver is down a bit as I write, but gold is slightly higher. Not much to report on the metals, as they both are trading in a pretty tight range.

Then there was this… The SEC brought charges against several former executives of the embattled mortgage giants Fannie Mae and Freddie Mac. They charged the six executives with securities fraud, saying they misled the public about the companies’ exposure to subprime loans during the mortgage meltdown. It is good to see someone finally having to face the music, but I have to think that there are many more executives with NY addresses who need to be brought up on some charges. While the mortgage giants certainly had a hand in the meltdown, the real crimes were committed on Wall Street.

To recap… North Korea’s leader dies, and causes some safe haven buying in the currency markets. The European debt crisis continues, and the rating agencies continue their downgrades. The ECB President refuses to step up bond buying, backing loans to European banks instead. Chuck is sick of all the Europe talk and instead focuses his attention on the US. And Fannie and Freddie execs are charged with fraud by the SEC.

Chris Gaffney
for The Daily Reckoning

The Daily Reckoning