Wednesday, September 13, 2006

Beware Options Expiry, CPI and the G-7

EUR/USD 1.2682 Hi 1.2703 Low 1.2665
USD/JPY 117.64 Hi 118.04 Low 117.53
AUD/USD 0.7518 Hi 0.7527 Low 0.7482
EUR/JPY 149.24 Hi 149.78 Low 149.11

There are a lot of records being set out there. The U.S. announced another RECORD Trade Deficit yesterday. With oil climbing to a record in July and exports slipping, the U.S. deficit increased 5% to $68.04 billion from $64.82 billion in June. This surpassed the previous record of $66.6 billion set last October. For now the markets are happy with that, after all the U.S. Trade Deficit is not exactly a new trend. A lot of analysts focused on the the fact that OIL prices were high, so that must be the problem. U.S. exports weren't exactly booming, though. They fell 1.1% to $119.97 billion. I guess now that OIL is down a little the U.S. will start running a Trade Surplus soon. Just kidding. Still the bulls were in charge yesterday. The USD held onto recent strength and the U.S. Stocks and Treasuries rallied.

The Chinese and Japanese also reached milestones recently: RECORD levels of FX reserves. Interestingly though, China also just announced that existing FX Reserves are ENOUGH. Which means, I guess, that the Chinese will stop recycling their export earnings into USDs and U.S. Treasuries. Markets ignored these comments. It's early days. This trend hasn't really taken off. Odds on though that if the U.S. Trade Deficit starts to fall it's because our Asian friends are no longer prepared to fund it.

Still the USD has held onto its recent modest gains against both the JPY and the EUR. And the market is still bullish the USD, particularly against the JPY. USD bullishness is supported more by positive carry returns and speculators than by real capital flows or economic fundamentals. The G-7 is set to meet this weekend in Singapore and the mutterings are about the need to see a realignment in existing currency parities. The U.S. and the IMF are NOT pushing for a STRONGER DOLLAR here, guys. What the U.S. wants to see is a devaluation of the USD which can be passed off as an Asian REVALUATION so as not to scare current holders of USDs and U.S. Treasuries. The U.S. can't afford to risk foreign capital inflows quite yet. And the IMF this week has noted the risks of a disorderly USD devaluation. That is: if the USD crashes the consequences could be nasty. The ECB has also made this point. Traders should note that NO-ONE in charge out there is talking about a USD revaluation.

This could be a very interesting END of WEEK. We have Options Expiry, the U.S. CPI release AND the G-7 meeting gets underway in Singapore. Central Banks are still talking various degrees of HAWKISHNESS, although real follow through is most likely in Europe. The move to quash global liquidity is not over yet. Asia and Europe are not done and there are all sorts of question marks about U.S. Monetary Policy. One thing is certain: the days of excessively easy money are ending. Financial markets haven't yet dealt with the consequences of that sea change.

OIL 63.94
GOLD 592.30

Commodities remain under pressure. For now this looks like position squaring but some commentators, notably the Super-Bear Stephen Roach at Morgan Stanley, is calling the top in the commodities cycle. The Roach view in a nutshell: a global economic slowdown is underway. This slowdown started in the U.S. Housing Sector and will spread to the rest of the world, particularly export-driven Asia, as U.S. demand for Asian imports take a dive. Not a spectacularly new view, but the one that stands up the best on examination.

With the market still long commodities the risk is for further selling pressure to emerge. GEOPOLITICS are off the agenda. Europe seems to be making progress with Iran. The possibility of another conflict, which was widely predicted before year end, now looks unlikely. So we have fading GEOPOLITICAL risks, the mass exodus of speculators from commodities and slowing global growth. The risk is for further falls in the price of OIL. A test of USD 60 looks likely. There is one caveat: that there is no substantial devaluation of the USD.

GOLD looks set for a test of USD 580 In the short term. There has been talk of European Central Banks selling into the GOLD market over the past week and the rush out of commodities will continue to weigh on the market. However, given that Central Banks such as China will have to find an alternative home for their export earnings (which are unlikely to disappear in the short term) the longer term outlook for GOLD remains positive.

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