Wednesday, September 06, 2006

Recession Coming Your Way

EUR/USD 1.2787 Hi 1.2833 Low 1.2778
USD/JPY 116.63 Hi 116.77 Low 115.97
AUD/USD 0.7664 Hi 0.7717 Low 0.7662
EUR/JPY 149.16 Hi 149.38 Low 148.64

The Global Economic Slowdown is getting more press. The IMF warning of the likelihood of a 'severe worldwide slowdown' in 2007 was front page on the Financial Times this morning. In their assessment the IMF suggests that higher commodity prices may yet force the hand of the FED. So we have inflationary pressures, a slowdown and further rate rises. This really is the 1970s.

Bernanke will have his chance to give his take on the situation with the release of the BEIGE BOOK in the States tonight. Bernanke, remember, is the guy who is an expert on the 1930s, the depression and DEFLATION. We are not dealing with another Volcker here. So it is unlikely that Bernanke will deal with the economic slowdown in the States, even while there are residual inflationary, by hiking rates aggressively. In fact, under Bernanke the FED is in PAUSE mode.

Bernanke is more likely to risk inflation and a USD DEVALUATION than a protracted, ugly recession. In this way the U.S. would export its domestic economic slowdown to its trading partners. So, while the IMF might not approve, from a USA point of view it remains an attractive (though not risk-free) option.

Data released in the States overnight confirmed the view that all is not well with the economy. U.S. home-price growth slowed in Q2. Actually the data showed the SHARPEST 3 month fall ON RECORD. The debt-laden U.S. consumer is not going to be happy. Still the news did nothing for Treasuries, which also slumped. The fact that weak economic data did not see buying in U.S. Treasuries should be taken as a warning signal. All is not well on U.S. financial markets.

The market will wait to hear from Mr. Bernanke before taking current trends further. If Mr. Bernanke comes across as relaxed about inflation and concerned about growth then it's odds on in favour of an attempt at REFLATION by the FED. Which means YIELD CURVE STEEPENING. The risks to the long end of the U.S. yield curve are quite significant at this point, particularly when you consider the dependency of the U.S. Treasury on foreign capital inflows to fund the
Federal Government Deficit, and the risks associated with holding USD-denominated assets IF the FED attempts REFLATION.

Meanwhile on the other side of the world Australian economic data is starting to show signs of strain. GDP growth for Q2 was just 0.3%, GDP numbers for Q1 were revised down.  Consumer Confidence is down. Like in other Anglo-Saxon economies it has been the Australian consumer, egged on by easy finance and the debt-financed housing boom, who has been the engine of economic growth in Australia for the past decade. Yesterday at its scheduled meeting the Reserve Bank of Australia left interest rates unchanged and there is now talk that interest rates may have peaked. This makes the AUD vulnerable.

Australia is running a large current account deficit, a large trade deficit and domestic demand is expected to remain under pressure as the cost of financing accumulated debt impacts spending. Speculative inflows into the AUD, attracted by high rates and the positive commodity story, are likely to reverse. AUD upside is seen capped at 0.7720 with a test of 0.7650 likely in the short term. The Australian
dollar can also expected to see weakness against the JPY and the EUR. It's back to selling the crosses. September is living up to its reputation as a bad month for stocks and, given the global economic outlook, more selling pressure can be expected.

OIL 67.84
GOLD 643.20

Weak growth, stories about possible OIL reserves in the Gulf
of Mexico and relative calm in the Middle East have all encouraged the OIL bears to re-emerge. This trend could have some way to go.

GOLD, on the other hand, continues to benefit from its status as the ANTI-DOLLAR and from fears that the FED is really going to pursue a REFLATIONary monetary policy. Global recession or not GOLD could be the reserve asset of the decade.

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