Monday, August 14, 2006

At Ease and Unwind

EUR/USD 1.2742 Hi 1.2765 Low 1.2709
USD/JPY 116.48 Hi 116.71 Low 116.15
AUD/USD 0.7661 Hi 0.7682 Low 0.7653
EUR/JPY 148.43 Hi 148.56 Low 147.87

Economic data released in Germany today, following the strong economic data released on Friday in France and Italy, points to further rate hikes in Europe this year. The ECB is expected to take rates to at least 3.5% (from 3% currently). And that has upset the USD bulls. Retail Trade numbers released on Friday in the States re-ignited talk of rate hikes in the States (with the favourite date for a hike September 20). The strong European Data released today and Friday confirms that growth is strong in the Euro Zone. With rates likely to rise further in Europe USD gains have been contained. The only factor in favour of the USD bulls right now is the fact that the market is
short USDs
.
Which is a point in favour of the USD, it just doesn't make for a huge new trend.

Markets are a chatter about the massive short USD positions out there. And the big question is: will they be unwound? The USD bulls are gearing up for another shot. Inflation due out in the States this week will be poured over to see if another rate hike can be justified. Any signs that the inflation beast has not been beat will be taken as confirmation that the FED will have no choice but to hike. (Which may or may not be the case. Bernanke certainly seems relatively relaxed about the inflationary threat.) So we are still trading on interest rate differentials. This is a bit like trading on old news. 2005 is long gone and the news at the margin is that rates are headed higher across the globe and economies which rely most on debt-financed growth will be hit hardest. Those economies are Anglo-Saxon. Which makes it hard to make a case for longer term strength in the USD.

Meanwhile GEOPOLITICS may take a back seat for a while. There is a cease fire in Lebanon and talk that the Israelis are no longer so keen to be the stooges for the Bush Administration's proxy war on Iran. With the chances high that the "Neo-Cons" will go the way of the Dodo at the next U.S. election, buying into the Neo-Cons Plans in the Middle East might just be a hard sell in Israel. It well may be that some Israelis feel that they have just two years to defeat their enemies in the area. It could also be that using the next two years to inflame hostility in the Middle East might not be an attractive option to Israelis. If that is the case, the cease fire will hold and the Neo-Cons will have to go back to the drawing board. The proxy war is over.

Stock markets are trading on peace and cheaper OIL and ignoring growth and higher interest rates for the time being. In any case rates are still historically at very low levels in both Japan and Europe and growth is not normally dependent on debt financing in either of these high-saving areas. In that environment there is room for stocks to rally, even if interest rates are set to move higher. The outlook for Anglo-Saxon stock markets is somewhat more problematic. The last five years of growth in these economies has been financed by an explosion of debt in the household sector and the associated rise in residential real estate markets. Both those engines of growth will suffer in a higher interest rate environment.

Oil 73.69
Gold 639.80

The failure of OIL and GOLD to make new highs at the height of the conflict in Lebanon, and despite the underlying bullishness of both markets, opens the way for a test of the downside this week in the wake of the implementation of the cease fire in Lebanon. The greatest potential downside is in GOLD, which is essentially a commodity of choice, not necessity. The initial downside target for gold is USD 620. A break would open the way for a move to USD 600.

While unwinding of speculative positions will see OIL also test the downside, the underlying global demand and ongoing concerns about supply suggest that downside potential is limited. A test of USD 70 is possible, but further weakness would need to be backed up by signs of slowing global economic activity. So far, while there are signs that Anglo-Saxon economies will slow in the second half of 2006 and into 2007 in response to higher rates, global economic growth remains steady.

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