Wednesday, July 19, 2006

Inflation Sneaks Back but will Bernanke Care ?

EUR/USD 1.2476 / 79 Hi 1.2512 Low 1.2458
USD/JPY 117.71 / 75 Hi 117.91 Low 117.19
EUR/JPY 146.86 / 90 Hi 147.13 Low 146.30

The New York Times reported today that the U.S. is waiting before it does anything about the Israeli offensive under way against Lebanon. Another 7 days or so of Israeli bombing to 'establish a buffer zone' and then the U.S. will apparently do something. Sending Condoleezza Rice in seems to be the extent of the "do something" plan. No mention that Israel's actions are illegal under international law. The Financial Times reports that Israel has already done an estimated $2 bn worth of damage to Lebanon's infrastructure. So I guess when this "offensive" (isn't that the perfect word) is over Lebanon will sue Israel for war reparations. And win.

At least we now have a time frame: 7 days. So if you ever stopped to wonder who is holding the remote on this conflict, you can stop wondering now. As soon as Israel gets the U.S. say-so it will stop bombing and move to the negotiating table.

After which it is expected that the three Israeli soldiers who are currently being held in Lebanon and Gaza will be released. Well maybe not. But in any case, with the excuse of the hostages, Israel will be able to reoccupy territory in Lebanon and Gaza indefinitely. Mission accomplished. Don't expect negotiations to start until after Israel has achieved its buffer zone.

Meanwhile data out in Great Britain, New Zealand and the United States all point to higher levels of inflation than markets had anticipated. The next big question being: will we continue to see rate hikes in Anglo-Saxon economies after all?? This news has seen recoveries in the USD, the NZD and the GBP. The carry trade may not be over yet. The idea is that, despite signs of slowing economic activity, inflationary pressures will continue to force the hand of Reserve Banks everywhere.

Stock markets seem to be taking all the negatives with relative calm. The Bernanke statement today will be the next test for the market. And Mr. Bernanke will have to tick a lot of boxes: yes the FED is aware that in some areas economic activity has shown signs of moderation but no the FED is not on the back foot when it comes to fighting inflation (and supporting the USD). The pressure will be on and Bernanke's only out will continue to be: the data, the data, the data. "We don't know how the data will pan out so we can't decide our next move already".

Should Bernanke come across as dovish on inflation and more concerned about levels of domestic economic activity today's testimony will define his mandate. Stocks will respond accordingly and only when and if there is a backlash in either the currency or Treasury market would there be negative repercussions for the Stock Market.

Oil 73.47
Gold 631.50

Dithering in commodity markets continues. But you only have to watch Nickel to know that the speculators are still out there in full force. If Bernanke's Testimony today begins a new USD down move, then commodity prices can be expected to recover accordingly. Volatility is sky high though and whiplash trading will continue.

If we really do have a return of inflation and Bernanke and his boys are happy to wait it out and see how past rate hikes impact on activity going forward then the case for higher commodity prices has been made. No question.

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