Tuesday, July 11, 2006

Dead Calm on FX Markets but Equities Look Vulnerable

EUR/USD 1.2724 / 27 Hi 1.2756 Low 1.2705
USD/JPY 114.54 / 58 Hi 114.70 Low 113.92
EUR/JPY 145.77 / 81 Hi 145.88 Low 145.17

FX Markets looking for direction keep focusing on the BoJ, which may move to hike rates Friday. Quite frankly: who cares ? The move, if it comes, has been fully factored in and isn't going to add anything to what is already known. Deflationary pressures in Japan have subsided and domestic demand has shown signs of recovery. As a result it is only natural to expect a return to normal monetary policy, which means that rates will have to move up quite a bit from current levels (say to 1.0 - 1.5%) if, and it's a BIG if, economic recovery continues at its current pace. The only surprise would be if the BoJ decides to sit pat Friday. Not that such a decision would change the lay of the land. It would only prolong the agony. Waiting for the BoJ is starting to feel a bit like waiting for Godot, and market anxiety surrounding this non-event is only slightly less absurd.

For now the FX market is stuck in range trading mode and waiting for a catalyst. The chances that the catalyst will be the BoJ decision Friday are negligible. Stock market action, though, bears watching. A break out on the stock market will either send the whole market scrambling to exit positions and cover risk (as we saw in May) or see a return to Goldilocks Nirvana. Goldilocks Nirvana though has been done to death. The risk for stocks remain to the downside.

And if Stocks take a hit so does the USD.

Insanely good Alcoa numbers released yesterday were considered disappointing by a hyped-up market. If market reaction to the numbers are anything to go by then the market is setting itself up for further disappointment. U.S. economic stats clearly point to a slow down in activity across the board. After 17 un-interrupted rate hikes, that is hardly a surprise. Particularly when you consider that the most recent U.S. economic expansion was built on cheap credit and the willingness of the U.S. Consumer to shoulder increasingly large debt burdens. As the cost of servicing that debt rises the pain in Consumer Land (and Real Estate Land) can only increase. Sooner or later results from Corporate America are going to reflect this changed economic landscape and less than stellar numbers this quarter should not come as a surprise.

Oil 73.98
Gold 633.50

OIL is holding at high levels but there is not enough anxiety in the market, or enough strong economic activity out there, for a break through recent highs. GOLD has seen a small rebound but any further moves will depend on the USD. Any sustained USD weakness will only increase the shift away from holding paper money by Central Bankers and strengthen the case for GOLD. The outrageous levels of leverage and speculation in both these markets mean that volatility in GOLD in particular is way out of proportion to changes in underlying fundamentals which means that taking positions is only for those with very deep pockets and a long term investment horizon.

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