Thursday, September 14, 2006

Waiting for a Break Out

EUR/USD 1.2702 Hi 1.2737 Low 1.2675
USD/JPY 117.58 Hi 117.79 Low 117.35
AUD/USD 0.7549 Hi 0.7570 Low 0.7510
EUR/JPY 149.39 Hi 149.69 Low 149.03

The FED's job just keeps getting trickier. While Leading Indicators of Domestic Economic Activity are POINTING DOWN it doesn't look like slowing domestic activity ALONE will be enough to quash inflation, unless of course domestic demand falls off a cliff entirely. Which is always possible but probably NOT a result the FED would be happy with. And the Bush Administration can't really afford to have an economic disaster on its hands to match its Foreign Policy Disaster. While you can spin the War on Terror as a necessary evil it's kinda hard to convince people at home that higher unemployment and falling standards of living are good for them. And, despite reports of vote rigging, the Bush Administration can't really afford to enrage the ENTIRE electorate. Well they could try but before long they would have to face down some kind of insurrection, which wouldn't be good. So the stakes are high and the pressure is on.

Data released today pointed out where the trouble is: Imported Inflation (care of USD weakness - the USD has fallen 2.9% on a Trade Weighted basis this year) and high international commodity prices (care of the War in Iraq, the rise of Asian demand, excessively loose international monetary policy etc.) are at the heart of inflationary pressures in the USA. Import Prices rose 0.8% in August and were up 0.5% ex-OIL. While the price of Imported Consumer Goods was unchanged and the price of Good Imported from China actually fell 1% Y/Y (that pesky TRADE DEFICIT again) the prices of Imported Industrial Supplies rose 1.8% ex-OIL. This is pretty basic stuff: the inflationary risk for the U.S.A. is imported. Domestic inflationary pressure may well subside as domestic demand slows BUT imported inflation is likely to remain a concern particularly if the USD comes under pressure.

AND the U.S. Public hasn't exactly thrown in the towel on spending, despite astronomic debt levels and higher domestic interest rates. Retails Sales for August which were released today were not high (up 0.2%) but were still higher than most forecasts.

Details, details, details. Everyone knows that the U.S.A. will be pushing for a weaker USD (sorry stronger Asian currencies) at the upcoming G-7 and everyone knows that the gigantic U.S.A. external deficit is the greatest threat there is to international financial market stability and global economic growth right now. The FT amused itself recently by publishing a spurious little article by John Kay suggesting that Italy MAY leave the Euro. And wouldn't that be exciting? And what would happen then? Yeah right. The real Argentina risk right now is spelled: U.S.A. and everyone from the IMF to Henry Paulson KNOWS IT. The BIG QUESTION now for the world is: how does the world and its financial architecture manage to rein in the U.S. current account deficit without causing financial market meltdown? And there are no easy answers.

Of course, trying to undermine alternative global reserves (EURO, GOLD whatever) serves the purpose of supporting the USD's fast diminishing status as global reserve currency. The argument wears a little thin, however, when economic fundamentals don't support the case for the U.S.A. being THE leading global economic power. And right now U.S. economic fundamentals are as BAD as they have ever BEEN. The catastrophic leadership provided by the Bush Administration has accelerated the process but the U.S.'s position as a Super Power has been eroding for decades. All the spin in the world from Paulson et al doesn't change that.

USD bears are getting back into gear. The USD/JPY has seen a medium term top at 118.00 and more downside can be expected from here. The G-7 can be expected to give the USD/JPY downtrend a little kick along. 117.00 is the near term target, but further downside can be expected. The EUR/USD looks likely to test 1.2800 in the short term and 1.2700 should hold the downside from here.

OIL 64.24
GOLD 601.00

Every analyst in the world, especially those who were calling OIL at USD 100 by the end of the year, have suddenly noticed that OIL has broken down. And now, of course, there is talk of wholesale reversal in commodity markets. The Asians, I suppose, are just going to slink off into the background and stop buying commodities. The optimism is such that some commentators now see USD 40 as the medium to long term target for OIL. And THAT reversal, from calling USD 100 to calling USD 40, took about a month. So much for PEAK OIL and all the doomsday crowd. Right now OIL has fallen a bit over 12% from its peak and is up about 300% from the lows registered in 2002. So we probably shouldn't get too excited about the BEAR CASE for OIL quite yet. Unless, of course, you take the view that the Global Economy is going to hit a brick wall in the near term.

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