Monday, September 04, 2006

USD Bears Back in the Driving Seat

EUR/USD 1.2850 Hi 1.2868 Low 1.2839
USD/JPY 116.25 Hi 117.13 Low 116.22
AUD/USD 0.7702 Hi 0.7707 Low 0.7663
EUR/JPY 149.40 Hi 150.40 Low 149.35

Well it didn't take much. One very good set of numbers out of Japan and the most popular carry trade on the planet suddenly looks at risk. Not that the BOJ (which meets this week) is likely to move rates hikes higher any time soon, but in a leveraged market it doesn't take much to set off a Tsunami. And that Tsunami has just started.

This week is unlikely to provide the USD with much relief. The week starts with a holiday in the States. The FED is scheduled to release its Beige Book on Wednesday. No other significant data is scheduled for release. Central Bankers in Japan, Australia and the U.K. will all announce monetary policy decisions. No changes are expected. Though recent data suggest that Australia and the U.K. have not seen the end of rate hikes just yet.

Market blatter suggests that you should watch Central Banks. The (dumb) idea is that if the data is strong then Central Banks will raise more aggressively. The residual belief is that Central Banks rule the world via interest rates. Central Banks count but it's NOT interest rates which are the problem. None of the world's Central Banks is on an anti-inflation crusade right now. The FED has PAUSED, rates in Japan are at 0.25% (think about that for a second) and in the Euro Zone rates are at 3.0% (and may reach 3.5% by year end) which is LOW. Rates in the big spending, low saving Anglo economies are higher. And here where there are real vulnerabilities. But the problem is not what DOMESTIC Central Banks may or may not do. The problem is FOREIGN Central Banks.

Central Bank buying of USDs in the wake of the ASIAN CRISIS provided the liquidity for the Stock Market rallies and other excesses in the U.S. economy. If those capital inflows slow or even (shock, horror) reverse then the economy and the Stock Market is at risk. So watch the USD. If the USD tanks, the Stock Market will follow. The real economy will get hit later.

And what is Henry Paulson about to do? Why trying to persuade the Chinese Central Bank to buy LESS USDs. Yes that's right, LESS USDs. Obviously the current U.S. Administration thinks it can parrot Rubin's Strong Dollar Policy, while encouraging FOREIGN Central Banks to buy LESS USDs. Careful what you wish for, Mr. Paulson. In 1997 Michel Camdessus, then head of the IMF, thought nothing of calling on Thailand to devalue. The crisis which followed was a sobering experience for the whole world. Though obviously not sobering enough. The USD is not exactly the darling of the financial markets right now, hedge funds are still on the prowl and the U.S. economic fundamentals make it vulnerable.

The USD bear trend looks likely to continue against the majors. The break below 117.00 opens up the way for the USD/JPY to test of 115.50 in the short term. Initial resistance is seen at 116.50. The EUR/USD has support at 1.2800 with a test of 1.2900 seen likely in the short term. 150.00 is expected to cap EUR/JPY with a test of 148.50 seen likely. Right now the market is being driven by speculators and position squaring. That said, all the fundamentals suggest the USD bear trend is likely to continue.

Stock Markets are likely to remain reasonably well bid in the short term. With rates on hold in the States on hold, growth resiliant in the Euro Zone and relative calm in the Middle East keeping OIL prices soft(ish), the current Stock Market rally can be expected to continue. That doesn't make it a low-risk trade, however. Storm clouds are looming.

OIL 69.14
GOLD 634.20

Despite the slightly softer overall tone of the commodity market and of OIL, GOLD remains bid. Given that GOLD is now the defacto-ANTIDOLLAR, this is hardly a surprise. Given the risks to the USD, buying GOLD on dips is still the way to go.

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