Sorting Out the Tax Cut and Unemployment Benefits Extensions

When I turned on the currency screens this morning, I saw that the euphoria of a currency rally, which we had talked about yesterday, had dissipated. I said to myself that it’s a case of “another day, another currency direction”… It all began mid-day yesterday, with gold and silver once again leading the way…only this time the way was down! UGH! Gold was down $24 as I left for the day… It’s down another $5 this morning…

I had read a blurb that came across the screens yesterday that once gold got to $1,430, the orders to take profits flowed like a river that swells from the spring rains! Was it just profit taking, though, that drove the shiny metal down $24? Probably not, as the program trading usually accounts for a sell off like that, when the fundamentals say the opposite.

The opposite is that the “Bernank” has publicly stated that they want to “inflate the economy.” Commodities are used to offset the damage that inflation does to one’s pocketbook… It’s that simple… Now… I don’t want you to think that I believe that gold is the only way to combat inflation… Gold is a commodity, but in reality, gold is the “uncertainty hedge.” It can act as an inflation hedge, but when you see hold screaming higher and higher all the time it is really an offset to the dollar… In fact, you may recall seven or eight months ago, when the euro (EUR) was losing ground daily, I said that the risk to the euro was that it could lose its position as “offset to the dollar”… I think that’s still working its way through and gold has taken over what the euro has lost…

The same can be said for silver…

Well… This back and forth on the dollar looks to me as though the markets are still attempting to digest the news that the Bush Tax Cuts were extended, along with the unemployment benefits. I’ll tell you one asset class that isn’t having any problem whatsoever digesting that news…and that’s bonds! Yesterday morning the 10-year Treasury was 3.01%…but by day’s end it was 3.19%! WOW! You don’t see moves like that in Treasuries very often… And for you newbies to bonds, let me say that the price and yield of a bond have an inverse relationship. In other words…when yields go higher, the price of the bond goes down, and vice-versa… So, Treasuries got rocked yesterday… But, it hasn’t just been yesterday… This has been going on for a month now…on November 10th, the 10-year’s yield was 2.63%, which was a bond price of 99 29/32’s (bond trade in 32nds) So, very close to par or 100, right? Well, that 3.19% yield is equal to a bond price of 95 9/32’s…

So almost a 5-point loss in 10-year Treasuries in the past month, and when you take into consideration the commission the broker charged you, it’s a 5-point loss easily! So what, you probably say? Gold lost $24 yesterday… Ahhh grasshopper… The difference is that bonds are not held in small amounts like gold…

But… The thing I want to point out here is that Big Ben is losing his battle to keep mortgage rates down… I think maybe the old “bond vigilantes” are alive… But they’ve got a lot more work to do! The bond vigilantes are bond market investors who protest monetary or fiscal policies they consider inflationary by selling bonds, thus increasing yields.

So… Since, in the bond market, prices move inversely to yields… When investors perceive that inflation risk is rising, they demand higher yields to compensate for the added risk. As a result, bond prices fall and yields rise, which increases the net cost of borrowing.

Now… You normally don’t see a rallying dollar when bonds are getting sold… But that’s another of the market movements you could depend on, before the financial meltdown in 2008… Everything we knew, changed… Will they come back? I sure hope so… I’m too old of a dog to teach new tricks to!

But in this case… I think this dollar strength versus rising yields are going on because the markets truly believe the bull about these tax cuts and extended unemployment benefits giving the US better growth prospects… Oops, did I say that out loud?

If the economy were to really grow (minus government spending) then that would reduce the need for Big Ben’s quantitative easing, eh? But… Here we have our Central Bank Chairman on 60 Minutes, and after watching some of it, did you notice his lip quivering like I did? At this point, I’m not sure my lips wouldn’t be quivering, if I were in his shoes! Anyway, what I was getting to, was a pointed comment that he believes that we do need more quantitative easing… And the markets are saying no… This should be interesting, eh?

Well… The Bank of Canada (BOC) left rates unchanged yesterday… I had thought that, of the four central bank meetings this week, the BOC was the only central bank that had a slim chance of hiking rates… But it looks like slim left town… So, rates remained unchanged… And the price of oil fell $2 yesterday, (again, another inflation fighting commodity…) So… Put the two together, and the Canadian dollar/loonie (CAD) lost 1-cent…

The Aussie dollar (AUD) also lost 1-cent in yesterday’s trading, and is off another 1/4-cent this morning… There were rumors circulating yesterday that China was going to announce another rate hike, in their never-ending attempt to cool down their economy. Whenever China announces anything that could slow their economy, the Aussie dollar takes a hit… But soon after, all’s forgotten, and the Aussie dollar continues to shine…

The Reserve Bank of New Zealand (RBNZ) will be the third central bank to meet this week, and the third central bank to leave rates unchanged… New Zealand received some bad news yesterday… It seems that in the northern part of the North Island, a drought has been declared… This region is the largest milk producing region in New Zealand, so… This is not good… Not only for the lost production in the milk industry, which could cause a hit to GDP, but also to the hydroelectric dams that produce power… The New Zealand dollar/kiwi (NZD) has sold off 1-cent too!

Tomorrow, the European Central Bank (ECB) will make it four in a row, for central banks leaving rates unchanged this week. The euro has seen some pressure this morning from a surprising weaker export report from Germany for October… Exports fell 1.1% in October, from September’s 3% gain… There are a number of reasons for German exports to weaken like the problems in the region, but the most compelling reason is that the euro was much stronger in October!

Someone asked me yesterday why I call the Fed Reserve the cartel, and most recently the “Bernank”… It’s just my way of trying to call it something closer to what it really is… There’s nothing Federal about it, and there are no reserves… And in the end… you should read the book… The Creature Form Jekyll Island

Then there was this… OK… So… I was thinking about the extension of unemployment benefits yesterday… and besides all the things I don’t like about it (and I’m not insensitive to being unemployed, I have been unemployed for more than six months before, and know what it was like…during which time, by the way, I never applied for unemployment, (not that there’s anything wrong with doing so!) but instead lived on savings… a novel approach, eh?)… The thing that will make people uneasy going forward is the fact that the unemployment rate will remain high, and… Probably move higher, because, as you know from being an astute reader of the Pfennig, after benefits run out, the unemployed are dropped from the BLS’s list of “unemployed”… So… In January, when 2,000,000 unemployed people were going to have their benefits expire, the rate would have fallen… But now… It will not…

The other thing this does, is allow people to spend more for the Christmas season… That sure gets the masses lathered up when retail sales are strong, even though we as a country spend more than we make…

To recap… The dollar selling ended mid-day yesterday, and a rally took place with dollar buying across the board, with gold losing $24 on the day! 10-year Treasuries got smacked hard with a nearly 20 basis point move higher in yields… Seems the bond vigilantes are at work! The Bank of Canada left rates unchanged and oil dropped $2, leaving the loonie down 1-cent from yesterday.

About Chuck Butler 105 Articles

Affiliation: EverBank

Chuck Butler is President of EverBank® World Markets and the author of the popular Daily Pfennig newsletter.

With a career in investment services and currencies extending over 35 years, Mr. Butler oversees all aspects of customer service and the trading desk for EverBank World Markets. A respected analyst of the currency market, Mr. Butler has frequently made appearances or been quoted by the national media. These include the Wall Street Journal, US News, World Report, MarketWatch, USAToday, CNNfn, Bloomberg TV, CNBC, and the Chicago Tribune.

Mr. Butler was previously the Chief International Bond Trader and Director of Risk Management for Mark Twain Bank, and has held significant positions in the investment industry since 1973.

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