Rate expectations push the US dollar higher.

* Dollar continues to push higher…
* What does the 10 year tell us???
* US debt levels scare Chuck…
* GBP moves back up…

And Now, Today’s A Pfennig For Your Thoughts.

Rate expectations push the US dollar higher.

Good morning and happy Friday. As is the custom when we pfill in for Chuck on the Pfennig, Frank has sent me an excellent introduction to today’s newsletter – so take it away Frank:
The reports are correct – TSA lines are long. Setting out from Saint Louis on Wednesday I managed a 35 minute wait in TSA-Pre and was happy that I didn’t have to stand in the enormous regular line. I would still be there. Like my graduate school professor Murray Weidenbaum (and author of Wage and Price Controls in the 1970’s) said – when an agency budget is cut, it doesn’t happen in DC, the end user service people are reduced until people call their representative and funding is magically restored. We’ll see.

I ended up Wednesday speaking at a conference across the street from the US Capital. It is a wonderful location and it produced many snarky comments about what goes on inside the building in full view which I will not relate here. Two senators and one congressional representative also attended and in short promised explicitly that nothing would be done this year on pretty much any topic. The odd thing to me was that these thoughts were related as matter of fact. The good news was that at least one suggested the budget deficit and subsequent national debt should be the highest priorities amongst those things that would not be done. Super.

But it does look like somebody is planning to do something. Over the past two days the release of Federal Reserve Open Market Committee minutes suggest strongly that there will be a rate rise in June. Most of the markets reacted badly to the news. While a major think tank last week opined that the Fed not listen to the market when setting rates, I think that it’s time for the market to find the right level by itself. A centrally planned economy hasn’t been shown to work yet, and I wonder what unintended consequences we’ll have to face shortly down the road will be. Seems like millions of investors attempting to discover pricing makes more sense than 12 economists reading pretty much the same staff reports. But who knows.

Thanks to Frank for getting us started this Friday morning. The FOMC minutes referred to by Frank continued to determine investor’s moods and the direction of the markets on Thursday. The dollar continued to climb higher, precious metals continued to drop and the equity markets drifted lower. The one and only outlier from yesterday’s reactions was the yield on the 10 year bond which actually dropped a bit at Thursday’s opening before leveling out and trading sideways through the rest of the trading day. In spite of all of the rhetoric we hear about an imminent rate increase, the US 10 year bond continues to show me that investors are calling the FOMC’s bluff – and that interest rates will stay ‘lower for longer’. Think about it – if investors really believed the Fed was going to be able to initiate 3 more rate increases in 2016, do you think the 10 year bond would still be yielding below 2%? I sure don’t.

And Chuck spent some time last night thinking about the debt we Americans have accumulated. He sent me a story on savings for the TTWT section and then followed that up with his own thoughts:
Well, I came home from my infusion, and ate lunch, then slumped into my recliner and didn’t wake up until 7 pm. The Cardinals were winning their game at the time, and it was beginning to get dark outside. WOW! I was really knocked for a loop! I’m not that much better right now, but when I saw some graphs that a dear reader sent me regarding “The United States of Debt”, I knew I was better than the state of our indebtedness here in the U.S. I sent a link to Chris yesterday, to some data regarding how a larger than you would ever imagine percentage of people would struggle at best to pay a $1,000 expense. And then these graphs came over and while I can’t print graphs on our text version of the Pfennig, I can give you the results in writing, so strap yourself in. I mean it, because these are going to be bumpy ride!

1. Household debt relative to GDP has decline since 2008, but remains higher than it was for almost all of postwar history.
2. Nonmortgage debt, which includes student loans, credit card debt, and auto loans is creeping back up to unsustainable levels.
3. Student loan debt now exceeds credit card debt, auto loans, and other nonmortgage debt!
4. Household debt relative to GDP is greater in the U.S. than in Germany, France, Italy and Spain!
5. The Average Household that has credit card debt owes $16,000. They owe $27,000 in auto loans, and $169,000 for mortgages. (no wonder they can’t make a $1,000 expense payment!)

That’s all I have from lake Woebegone. I know this stuff is boring, but you need to know the state of the U.S. consumer, and why retailers are flat on their backs, and GDP, which relies on consumption, can’t get off the mat. And the Fed wants to hike rates? I would find that funny, if it weren’t true, and besides, I’m in no mood to be entertained right now!

It was fairly light in the data department yesterday, so the weekly jobs numbers and the April leading economic index took center stage. The initial jobless claims showed improvement from the previous week and the current reading of 278k represents the 63rd consecutive week of claims below the 300k mark, which is the longest such streak since 1973. While the four week average ticked up a bit, it still remains in a very healthy range so many economists view this as continued evidence of a robust labor market. With Janet Yellen at the helm of the Fed, the labor market and more specifically wage increases will continue to be the ‘trigger’ for any additional interest rate increases. Yellen is a dove at heart, and much of her academic studies prior to her appointment as the Fed Chairwoman was centered on the labor markets. I continue to believe the FOMC will wait for a move higher in wages prior to pushing rates up; Yellen and company would rather error on the side of higher inflation than being blamed for killing the nascent recovery and fragile wage growth which has accompanied it.

The leading index, which is comprised of ten different components, came in much higher than March and exceeded the initial estimates by rising 0.6% during the month of April. A director at The Conference Board said “the US LEI picked up sharply in April, with all components except consumer expectations contributing to the rebound from an essentially flat first quarter. Despite a slow start in 2016, labor market and financial indicators, and housing permits all point to a moderate growth trend continuing in 2016.” Both the jobs data and this leading index pushed market sentiment toward a June rate hike by the Fed, so the result was a stronger dollar and a continued selloff in metals.

Shifting gears into today, we only have one piece of data on the books and it’s the April existing home sales. There aren’t any surprises expected, so if the experts are correct, we should see a slight pickup in sales for the month. Looking ahead to next week, the volume of data will be on the slow side but we’ll see a hodgepodge of various reports that will include some housing data, durable goods, and the second reading of 1st quarter GDP. The current expectations of these reports would paint a continued recovery picture, so with a relatively slow week and traders putting more emphasis on data, we might be poised for another week of dollar strength.

The G7 meeting of central bankers and finance ministers opened in Japan this morning, but markets are expecting much from this meeting. While most of the currencies have given back recent gains vs. the US$, the pound sterling is bucking this trend. The pound is the best performing currency vs the US$ this month, and is the ONLY currency which has been able to post a gain vs. the dollar in May. Sterling soared yesterday after retail sales for April almost tripled economists’ expectations. Sales jumped 1.3% in April gaining 4.3% on an annual basis. This strong data print combined with Brexit polls showing the UK will stay in the EU to push the pound to a high of 1.4644 before profit taking eased it back a bit.

Higher rate expectations have weighed on the precious metals with Gold set for the biggest weekly drop in two months. Early European traders have edged the prices of precious metals higher, but this week’s shift in rate expectations and a stronger US$ have both led precious metals to pare back some of their YTD gains. Fed President William Dudley reiterated the recent Fed message that rates could be moving higher in June or July as long as the US economy continues to strengthen. And while many investors (me included) question whether or not the FOMC will want to make a move the week before the Brexit vote, Dudley said the Fed would ‘weigh up’ the risks of a Brexit when considering raising rates. So if the chances of a Brexit remain low, then the FOMC may not worry about raising rates in front of this very important vote. Without much data out this morning the markets will probably ‘range trade’ today.

And to end today’s Pfennig we have a news story which should in my opinion be receiving a lot more attention. Central banks have been engaged in a ‘war on savers’ with their ZIRP and NIRP policies which are designed to get consumers and businesses to spend spend instead of save. The nascent recovery here in the US certainly doesn’t look like this strategy has worked, but taking a look at the average American’s balance sheet reveals that they have been able to accomplish half of their goal (keeping savings rates down). Here is the story forwarded to Chuck by a loyal Pfennig reader and EverBank employee (Thanks Brian!!): http://bigstory.ap.org/article/965e48ed609245539ed315f83e01b6a2

Currencies today 5/20/16. American Style: A$ .7228, kiwi .6769, C$ .7626, euro 1.1216, sterling 1.4558, Swiss $1.0087. European Style: rand 15.7385, krone 8.324, SEK 8.3303, forint 282.15, zloty 3.9381, koruna 24.083, RUB 66.884, yen 110.32, sing 1.3808, HKD 7.7669, INR 67.46, China 6.5510, pesos 18.3822, BRL 3.5442, Dollar Index 95.268, Oil $48.17, 10-year 1.854%, Silver $16.49, Platinum $1017.20, Palladium $558.18, and Gold $1,256.31

That’s it for today. This was truly a group effort this morning with Frank, Chuck and Mike Meyer all helping me get this out – thanks guys! The Blues just don’t seem to be able to get their engines back into gear vs. the San Jose Sharks and dropped another game last night. Needless to say, tomorrow night is a must win for the Blues. Rain greeted me again this morning, but I hear the weekend is going to be sunny and warm so we have that going for us. I hope you have a Fantastic Friday and Wonderful Weekend. Thanks for reading the Pfennig.

Chris Gaffney, CFA
EverBank World Markets