Tuesday, September 19, 2006

That's It, It's Over. Now we go Back to Basics

EUR/USD 1.2660 Hi 1.2727 Low 1.2651
USD/JPY 117.54 Hi 118.14 Low 117.48
AUD/USD 0.7532 Hi 0.7566 Low 0.7530
EUR/JPY 148.81 Hi 150.29 Low 148.69

The USD has done all it can on the back of the G-7 failure to call for YEN strength. And it's been a fairly pathetic showing. Indeed, the USD bulls - who were so excited that there was not a concerted G-7 call for the USD/YEN to depreciate (a lot) - never stopped to ask themselves why Henry Paulson and his G-7 buddies thought best to avoid that particular topic and the associated risks. They didn't have to wait long for the answer. Next day: bang! The U.S. Current Account Deficit was back in the news. And the news was considerably worse than the pretty awful USD 218 billion headline DEFICIT which the U.S.A. recorded in the second quarter of 2006.

The details make ugly reading. The U.S.A. recorded a USD 4 billion net INCOME DEFICIT for the quarter. Which underlines the U.S.A.'s position as a debtor nation. There was a revision from a USD 1.9 billion Income Surplus in Q1 to a USD 2.5 billion Net Income DEFICIT. Which means that someone overestimated the U.S. Income Account by some USD 4.4 billion in Q1. What's more foreigners (mostly FOREIGN CENTRAL BANKS) now own nearly half of the USD 4.3 trillion Treasury market. The U.S. really NEEDS these foreigners to hold onto their U.S. Treasuries. It also needs them to continue to buy more. That's why Henry Paulson can't go tripping around the world to suggest that it's time the USD/JPY took a hit (sorry that the YEN revalues) because it would put at risk the whole U.S. Government Funding Programme. And with a war on in Iraq, Tax Cuts to Fund, and another war planned for Iran (and this time the U.S. really IS going in alone), not to mention the War in Afghanistan and the upcoming elections in November (which will require a bit of pork), there isn't room or time for a massive reduction in the Government's Funding Requirement.

No the really BAD NEWS was that in July the U.S.A. failed to attract the necessary capital to FUND its yawning external deficit. Net Capital Inflows for July came in at a measly USD 32.9 billion, which was less than half what was forecast and obviously a whole let less than the U.S.A. requires to keep the USD stable. This is how it works: either the U.S. sucks in enough money to meet its external funding requirement (circa USD 70 billion a MONTH) or the USD depreciates. A failure of confidence in the USD would not do a whole lot to encourage foreign investors to rock up for the next U.S. Treasuries Funding party, so Paulson stepped very carefully at the G-7. And his carefulness, more than anything else, should wake up market participants to just HOW PRECARIOUS the situation is. And how close we are to a massive USD depreciation.

For now the CARRY TRADE CROWD really is carrying the USD. But speculators get hurt. These are not real capital inflows and you don't need to meditate long on what happened in Hedge Fund Land this week to understand how badly this all could end. And when one fund goes criteria for everyone else gets tightened. Limits get scrutinised. Risks get reined in. And that is happening NOW.

PPI numbers released in the States today (which were lower than expected) don't really add anything to the general scenario. Except that they do confirm that Ben Bernanke and his DOVISH team at the FED are unlikely to hike tomorrow. Great. So higher short term interest rates will not be there as an added attraction to stock up on USDs. Same goes for the ugly news out of the U.S. Housing Sector (surprise, surprise).

GOLD 588.20
OIL 63.69

Gold (the anti-DOLLAR) seems to be doing just fine, even if inflation numbers are low right now and even if world growth is expected to run into trouble soon, meaning of course that the short term inflationary risk is not HUGE. The steady performance of GOLD is not about its role as a hedge against inflation, which it is. GOLD's big advantage is that it is NOT the USD. And that makes it a very compelling investment right now. Which is why this rally has legs.

Weaker world growth will not be good news for OIL, however, there does seem to be some lingering concern about the determination of the U.S. Administration to start a new conflict in the Middle East. And that would light a fire under the price of OIL. So the market remains caught. For OIL to see a serious decline the world needs to know that the U.S. Administration IS NOT planning another Middle East adventure. That is not yet clear.

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