Monday, July 17, 2006

No News is Good News ?

EUR/USD 1.2523 / 26 Hi 1.2658 Low 1.2510
USD/JPY 117.17 / 21 Hi 117.32 Low 116.14
EUR/JPY 146.73 / 77 Hi 147.17 Low 146.48

The G8 provided the chance for our fearless leaders with a change of scenery and that's about it, really. Oh and it gave us a snapshot of just how disunited the G8 is on just about every issue you could imagine. There was no real guidance on the recent escalation in violence in the Middle East, except for a very weak 'please stop' to all those involved. There was no guidance on currencies, no guidance on world growth, world trade or in fact on anything meaningful.

More importantly there was no signal that recent escalation in the Middle East will be met by any kind of action by any major power. So there is no reason to expect hostilities to calm down on that account.

Perhaps the rise in the OIL price, which the escalation around Israel has created, is not wholly unwelcome. Russia, oil producers in the Middle East (who after all are not located in Syria, Lebanon or Israel), and America's oil millionaires are all raking it in. Which means the incentive for doing something about the increased violence, or the rising price of oil, isn't really there.

What's more in this environment rate hikes can be blamed on OIL, which is convenient. No need to mention policy failures in other areas and all of the negative economic consequences of rising interest rates can be blamed on "terrorists", who are foreign, elusive and unelected.

In a way it's almost a perfect set-up. Although not for the man in the street. But let's be honest, the man in the street is not making the decisions here and the most important thing for the people who do make these decisions is: how do you sell them to the man in the street? Rates may have to be hiked, not to save the USD or to compensate for incompetent fiscal policy, but because oil is increasing inflationary risks. And oil is rising because of those nasty, foreign terrorists. Perfect.

Policy makers in the States can hardly be unaware of the risks. Paul Volcker pointed out Friday that , because of U.S. dependence on foreign capital, "it is critical that we maintain confidence" in the USD.

The crisis in the Middle East has provided the USD with much needed safe haven buying, but we are not out of the woods yet. So financial market will be sifting through the tea leaves after Bernanke speaks Wednesday and, given the hints from Volcker and others, it's hard to believe that he won't make all the right noises about containing inflation.

The question of the quarter is: will stock markets be sacrificed on the altar of USD protection?

Oil 75.80
Gold 652.70

A stronger USD has seen profit taking in both the GOLD and OIL markets, despite the Middle East unrest. Volatility, as usual, remains the name of the game.

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