Thursday, September 28, 2006

Alive and Kicking in the EuroZone

EUR/USD 1.2722 Hi 1.2735 Low 1.2699
USD/JPY 117.55 Hi 117.71 Low 117.32
AUD/USD 0.7498 Hi 0.7518 Low 0.7493
EUR/JPY 149.54 Hi 149.77 Low 149.11

In the EuroZone the data continues to be positive. Not that you would notice it all that much if you read the wires. But the cumulative information released in the last little while points to a broadening economic recovery. If the same numbers had been released in the States there would be talk of economic resurgence. Here in Old Europe the euphoria has been less noticeable. In fact there hasn't been any.

In the States though analysts pour over the data looking for the GOOD NEWS. Some suggested yesterday that the 4.1% rise in New Home Sales (to 1.05 million) might represent some kind of bottoming in the housing market. Of course if you revise down the August numbers, we may get the same kind of bounce AGAIN in September. July sales were originally reported as 1.072 million - higher than August - but the July numbers were then revised to 1.009 million. So in August there was a bounce. If you make revisions like this every month, you could KEEP recording a bounce even as the housing market keeps sliding. Which it is. The volume of New Home Sales was down 17.4% with respect to a year earlier and there was a fall in the Median Home Price for the first time since 2003. Builders have been forced to cut prices and offer incentives to buyers just to shift inventory. What's more, Durable Goods numbers for August came in sharply below expectations and saw the first back to back decline since April - May 2004.

But no matter, the market is taking the view that the worst is past. Or rather that the worst is past with regard to inflation and that the FED can cut rates soonish. Indeed, some people at the FED seem to believe that inflation has peaked. This has been good news for the U.S. Stock Markets, right on time for the November 7 United States elections.

Meanwhile in Europe the ECB is talking and talking EXTREME vigilance. Which means there will be another rate hike on October 5th and possibly more rate hikes before the end of the year. It is widely expected that short term rates in the EuroZone will reach 3.5% by the end of the year. All up, economic data out of the EuroZone supports the view that monetary policy accommodation can be removed. GDP growth is the strongest it has been in 6 years. In France Consumer Spending posted the biggest rise in 7 years in August this year. Consumer Confidence in Germany is at its highest level in almost 5 years. Italian Business Confidence rose in September, Government Tax receipts in both Italy and France have been stronger than expected as a result of improved business conditions and Corporate Borrowing is growing and German Unemployment fell again In August.

So we have a rate hike on the way in Europe and a rate cut planned (maybe) for the United States. But is the Carry Trade Crowd listening? No, it is not. The big idea making the rounds at the moment is this: with U.S. Stock Markets doing well capital flows are going to come pouring into the United States in the run up to the November 7 elections. And with interest rate differentials still favourable to the USD there is only one way for the Dollar right now: UP. Sound good? Well think about it: U.S. Stock Markets are testing highs at a time when the FED is thinking (maybe) about easing because the Housing Market slump is broadening and Consumer Spending is taking a dive. The economic consequences of this Housing Market slump haven't yet played out. But when they do it's likely to be ugly.

And then think about this: while the big old USD bull case was making the rounds the price of GOLD went from near USD 590 all the way to USD 610. Why? Well because the Central Bankers of Asia are looking to diversify their FX holdings. Paulson has asked them to and Asian Central Banks KNOW what happens when you put too much faith in the USD: you get hit. Been there, done that, got the Plaza Accord postcard. So the Chinese and the Japanese don't want to keep buying the BUCK. The Americans don't want them to either. The Europeans are not happy about the idea that they may just switch their stock of FX Reserves into Euros, driving the Euro up still further. So where is the money going: GOLD that's where. Which means that it's not going into USDs, U.S. Treasuries or U.S. Stock Markets.

The Carry Trade Crowd should stop worrying about interest rate differentials, which in any case are gradually being eroded, and start worrying about DIVERSIFICATION. This is a big new idea, a big new trend and it means that the U.S. will stop receiving all that nice easy money which it has been relying on for so long. But, like the guys at Amaranth, while there is a BIG IDEA (commodities can only go one way) which works for a while it's hard to give it up. And right now the big idea is NOT diversification, but CARRY. So we will have Hedge Funds and Punters lining up on every dip to buy the USD. They should start to worry though if there are no signs that the Central Banks of the world are with them on this one. So watch what happens to U.S. Treasuries. If, despite the weak economic conditions in the U.S. and the talk of slowing inflation, there is no significant rally on U.S. Treasuries then that is a sign that, just maybe, the Central Banks of Asia are going elsewhere with their money. And that would NOT be good news for the USD.

EURO strength can be expected to continue, on the crosses and against the USD. The economic statistics and the likelihood of a rate hike next week all support the EURO. For once the EURO is leading. The EUR/JPY is now back at levels which concern Central Banks. This opens the way for USD/JPY downside.

OIL 62.59
GOLD 609.40

GOLD continues its role as the ANTI-DOLLAR. Buying on dips remains the recommended strategy for medium to longer term investors.

All the bearish news seems to be in the OIL market. Should we fail to see a decisive break below USD 60 in the short term, this suggests that a trading range of USD 60 to USD 75 has been established. More information will be required before this trading range can be broken.

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My name is Chikashi Munakata in Japan.
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Hi, Sure go ahead.
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