Friday, September 22, 2006

Non-Events and Nixon Moments

EUR/USD 1.2829 Hi 1.2833 Low 1.2776
USD/JPY 116.30 Hi 116.63 Low 116.19
AUD/USD 0.7554 Hi 0.7580 Low 0.7550
EUR/JPY 149.20 Hi 149.36 Low 148.60

The Bush Administration is having another Nixon moment. I guess Cheney and his buddies are still mourning their glory days with Tricky Dicky. And surprisingly, there is one thing that Nixon did achieve, his one legacy in an Administration marked by war-mongering and incompetence (sound familiar?): Nixon opened up relations between the U.S. and China. Shortly thereafter Deng Xiao-Ping announced that "To get rich is glorious" and subsequently China announced its Open Door Policy. Not that it is Paulson's trip to China which we are focusing on here. No, what could be interesting is the possibility that the Bush Administration decides NOT to bomb Iran but to go to the negotiating table and hammer out a deal.

Should President Bush actually manage to make something positive out of the mess he and his predecessors have made in the Middle East this would go some way to establishing his legacy. Not that New Orleans or the Iraq disaster would be forgotten, after all Nixon's reputation never really recovered, but a deal with Iran would certainly be better than another U.S. bombing campaign in the Middle East. Bush's softly, softly stance on Iran which emerged this week may just mean something. Provided of course someone can persuade that little politician from Iran to shut-up and move off centre stage. He may think he's a dab hand at negotiations and public relations but he seriously risks overplaying his hand. Bring back the Ayatollahs. If nothing else, they have a better dress sense.

Well the FED met this week just to catch up, chew the fat and do nothing. Just like everyone expected. Another non-event is planned for late October. Initially the market was happy. The confirmation that the FED is in PAUSE MODE helped the Stock Market bulls and U.S. markets made new highs. Records are tumbling all over the place. But the records to watch are those being broken on the U.S.'s ever rocketing current account deficit, the U.S.'s record level of Foreign Debt and the fact that the U.S. Treasury is relying on foreign investors to pick up circa 50% of the paper on offer at every new funding round, and there are plenty of those. Though the Stock Market bulls are a teensy bit concerned that the FED is in PAUSE MODE because the U.S. economy is gonna make a hard landing pretty soon. Data out this week in the States hasn't exactly been all joy and light. And there are worry warts out there starting to talk about just how hard the recession is going to be.

But not to worry Henry Paulson is on the case, encouraging the Chinese to buy less USDs so as to make the U.S. more internationally competitive. Everything will be fine. EVENTUALLY. Right now though the THEME on FX Markets, if you can call it that, is range trading. Ranges which have been in place pretty much since before the Summer are still holding. And so the market is complacent. The FAVOURITE TREND is the CARRY TRADE: you make points, you trade the ranges. Until of course those ranges break and all hell breaks loose. For now everyone is happy. So what if the FED has moved from HIKE MODE to PAUSE MODE, so what if the U.S. Current Account Deficit is 6.6% of annual GDP, so what if China and Japan are holding record levels of FX Reserves and are looking to diversify away from the USD, so what if the USD share of those reserves is falling, so what if Paulson is talking up the Chinese Yuan (and the currencies of all those naughty countries who continue to run large current account surpluses), the Carry Trade has been a winner and you don't stop backing a winner until you HAVE to.

Meanwhile, with the CARRY TRADE crowd looking the other way, the USD is slipping. The ECB is lining up to fight off the Carry Trade on the EUR/JPY. The recent EUR/JPY historical high is going to be just that. Though we may have to break decisively below 148.50 before we see a rush for the exits. And even then, those nostalgic for those lazy, point-earning Summer trades will keep on buying dips. This is a bad idea, but having to refocus and reassess is hard work. With the ECB holding down the fort on EUR/JPY and the USD seeing selling pressure, the real downside action will be on USD/JPY. USD/JPY is unlikely to see 117.00 again in the next little while, and anything above 116.50 should be sold. That doesn't mean that the EUR/USD uptrend is over, it just means that each new USD down move will start in the USD/JPY and then move to the EUR/USD. Though, ultimately this is not about crosses. This is about the DOLLAR and the USD downtrend is not over, not even close. Anything even near 1.2700 on the EUR/USD should be bought. The near term target is still 1.3000.

Other carry trade favourites: the AUD and the NZD look vulnerable. New Zealand just released spectacularly BAD current account numbers. The New Zealand current account deficit just reached 9.7% of annual GDP, which is Banana Republic territory. With those kind of numbers you need sky-high domestic interest rates just to keep the currency afloat. Think Iceland. Australia's numbers are slightly better, but still poor. Selling AUD and NZD versus the JPY is recommended. AUD/JPY is not expected to hold a break above 88.00 and 77.00 should cap the NZD/JPY.

OIL 61.98
GOLD 593.60

GOLD will benefit from the USD down move, increased global uncertainties (Thailand, Hungary, Iran, Afghanistan and so on and so forth), and the search for a safe haven. The GOLD rally continues.

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