Good day. It is finally here, the day investors have been waiting for. This afternoon the FOMC will finish their two day meeting and Chairman Bernanke will let us know if they have decided the US economy is strong enough for them to reduce their support.  Markets have been fairly quiet leading up to this announcement, and I don’t think we will see anything different today.

The dollar was mostly unchanged yesterday but began to drift higher in overnight trading.  I spoke to a couple of different reporters yesterday who called to get my opinion on the markets as we approach today’s ‘taper’ decision.  I let them know that while I am still in the opinion that the FOMC will wait until next quarter before reducing their bond purchases, the markets have largely ‘priced in’ the taper. So unless Chairman Bernanke comes out and cuts the bond purchases altogether or increases the bond purchases, I don’t think the markets will react in a dramatic fashion. The members of the FOMC have made it very clear that while they will begin cutting back the amount of bond purchases, they will not be raising interest rates anytime soon and will continue to support a very accommodative monetary policy throughout 2014.  The printing presses will continue to work in overdrive here in the US, and the FOMC will continue to give the markets all the support they need.

One of the reasons I believe the Fed will choose to wait on the taper today is the fact that reported inflation continues to remain well below the Fed’s 2% target.  The CPI report for November was released yesterday morning and showed prices were flat compared to the previous month while the YoY figure showed a 1.2% increase.  Both of these readings were below economists’ expectations but were slightly higher than last month’s CPI data.  As I pointed out yesterday, the Fed would like to see inflation ‘heat up’ to a 2% level as they continue to worry the US is entering a deflationary spiral similar to Japan.  But the situation in Japan is very different than ours here in the US.  One of the biggest differences is that the savings rate in Japan has traditionally been much higher than here  in the US.  Japanese consumers continued to save even after interest rates went negative.  Here in the US our consumers tend to borrow and spend instead of save – so we are in less danger of slipping into a similar deflationary environment.  But the members of the FOMC still want to see some price increases, so they will likely hold off any ‘taper’ with the thought that they will continue to pump more and more money into the markets until we see some sort of inflation.

Many of you may be asking yourselves ‘Why has the $85 billion bond purchases not caused the inflation rate to increase?’  The answer is in the velocity of the money being produced by the folks at the Fed.  Our friends over at the 5 ran a chart yesterday afternoon which explains this in a more graphical way.  This chart caught the attention of Chuck Butler who asked me to share it with Pfennig readers.

agora chart

Chuck had this to say about the chart: When all this money stops sitting here collecting interest, where do you suppose it will go?  Did I hear you say…  the economy? Well, yes… it will… and when it does…. The velocity of money will spin out of control, as will inflation!  Better hold onto your Gold!

Chris again. We have explained the concept of the velocity of money in past Pfennigs, but I will give new readers a quick explanation.  The Fed attempts to stimulate the economy by putting dollars into the system.  Under normal circumstances, the dollars the Fed spends on bonds which they purchase from banks get lent out to companies and individuals who then spend or invest these dollars with other companies or individuals who again spend or invest these dollars, and this process repeats over and over.  This is what is referred to as the ‘turning over’ of the money and the speed at which these funds change hands is measured by the ‘velocity’ of money.  But following the financial crisis, banks have kept a majority of the funds they are being paid for the bonds in reserves; choosing to shore up their balance sheets and increase reserves instead of lending these funds out.  This has caused the velocity of money to slow to a crawl and has also kept a lid on inflation.  However, as Chuck points out at some point these banks will begin putting all of this liquidity back into the markets and when they do we could certainly see inflation zoom higher.  Chairman Bernanke and the other members of the FOMC are confident they can pull all of this liquidity back out of the market before inflation becomes a problem, but can they?

But enough of the economics lesson – most of you read this letter to find out what is going on in the currency and metals markets so let me get back on track.  As I mentioned in the opening paragraph, the dollar was mostly unchanged yesterday but started to drift higher overnight.  The yen weakened for the first time in four days vs. the US$ after a report showed Japan had a record trade deficit in November. Data released yesterday showed Japan posted a deficit of 1.29 trillion yen last month, marking a record 17 straight months of deficits.  The BOJ has been the largest

The euro remained near the two year high level of $1.3833 which it hit in October. Not a lot of data coming out of Europe but news out of the Euro zone finance ministers meeting did help the euro slightly.  Finance ministers have apparently made progress on a plan to close banks, which is part of the overall ‘banking union’ which is hoped to restore confidence in the European financial sector.  This banking union is needed as part of the strategy to strengthen the ties in the EU to better deal with financial problems such as the recent debt crisis.  The euro has also been strengthened by banks repatriating funds to shore up their capital bases prior to the ECB’s asset review.

The pound sterling gained slightly after a report showed the UK’s unemployment rate fell in October.  The rate decreased to a four year low of 7.4% from a previous reading of 7.6%.  But sterling gave most of these gains back after another report showed UK inflation is not a concern. Consumer prices in the UK rose 2.1% on the year, the slowest increase since November of 2009.  Some had started to price in an early rate hike by the BOE, but this inflation report suggest interest rates will remain where they are for the near future.

The Australian dollar continued to slide after the release of the minutes of the RBA’s December 3rd meeting suggested the officials back Governor Stevens in his call for a weaker currency.  According to a Reuters story, Australia’s government has also apparently abandoned any intentions of returning to a budget surplus and predicted deficits for the next decade if spending cuts are not enacted.  The Australian deficit is expected to swell to A$47 billion in the year to June, from A$30 billion announced in August.   We continue to favor the kiwi over the Australian dollar, as the two country’s economies continue to diverge.  The government of New Zealand ramped up their economic growth forecasts for next year while sticking to their plan of returning to a budget surplus in 2015.  The New Zealand government also announced a reduction in debt issuance this year, apparently the stronger growth has decreased the need for additional borrowing.  The good news just continues to roll in for the kiwi.

To recap. We all await the decision by the FOMC on bond purchases.  The announcement at 2 pm will be the last time Chairman Ben Bernanke gets to tell the markets what the FOMC decided. The velocity of money remains at a crawl as can be seen by the CPI data released yesterday.  The Japanese yen was sold off vs. the dollar, but the euro and pound remained stronger.  The AUD and NZD economies continue to diverge, with good news continuing to support the kiwi.

Currencies today 12/18/13. American Style: A$ .8901, kiwi .8246, C$ .9398, euro 1.3749, sterling 1.6358, Swiss $1.1256. European Style: rand 10.342, krone 6.0917, SEK 6.5422, forint 217.05, zloty 3.0415, koruna 20.147, RUB 32.9575, yen 102.96, sing 1.2587, HKD 7.7521, INR 62.101, China 6.1105, pesos 12.9585, BRL 2.3235, Dollar Index 80.126, Oil $97.33, 10-year 2.8464%, Silver $19.91, Platinum $1.348.25, Palladium $704.40, and Gold. $1,233.10

That’s it for today… Well it doesn’t sound like our office pool won the Mega Millions jackpot of $636 million.  We all chipped in a few bucks to buy some tickets and even though we are smart enough to know our chances of winning are miniscule, it still is fun to imagine how we would spend the winnings.  Apparently there were two winning tickets sold, but neither were here in the St. Louis region.  But no early Christmas present for us here in World Markets. Blues lost their game last night here at home and dropped another couple points behind the Central division leading Chicago Blackhawks.  I hope everyone has a Wonderful Wednesday, and thanks for reading the Pfennig!

Chris Gaffney, CFA
SVP & Director of Sales
T. 314-951-1619
EverBank World Markets
8300 Eager Road, Ste. 700,

St. Louis, MO. 63144

 

---

Click here for important disclosures.