Friday, October 13, 2006

More Records

EUR/USD 1.2521 Hi 1.2578 Low 1.2510
USD/JPY 119.59 Hi 119.69 Low 119.07
AUD/USD 0.7502 Hi 0.7535 Low 0.7499
EUR/JPY 149.76 Hi 150.20 Low 149.63

Well the Karl Rove election strategy doesn't seem to be going to plan. Although the Dow Jones just hit ANOTHER record high, George W. Bush's approval ratings just hit a record low. According to a recent Newsweek only 33% of Americans approved of Bush. Obviously these guys don't know when they have it good. But there are still 3 weeks and one FED RESERVE board meeting to get through before the November 7 election, so don't write off Karl Rove's October economic surprise quite yet. Although the Foley surprise seems to be getting slightly more press right now. The U.S. votes in the right to torture and you hear not a peep out of the electorate but a few salacious e-mails and VABOOM, catastrophe hits the Republican re-election strategy. The Puritan heritage is alive and well and living in America.

Meanwhile the fabulously competitive U.S. economy just hit another milestone: another record Trade Deficit. In August the U.S. recorded a USD 69.9 billion deficit. There were record deficits in the U.S. Trade with China, Mexico and OPEC. Analysts have been quick to seize on the OIL component and point out, helpfully, that OIL prices have since declined. The idea is that this should go some way to reducing America's Trade Deficit in the months ahead. It's not a lot to hang your hat on, but then you go with what you've got. As a result of America's appetite for imports, GDP growth for the 3rd quarter is likely to be a bit soft. Forecasters are calling for an GDP annual growth rate of sub 3%.

While OIL supposedly took the shine off the U.S. Trade performance, Japan managed to record a 36% year on year increase in its Trade Surplus in August. Its Current Account Surplus was up 22.2% year on year. So I guess when cheaper OIL prices hit the Japanese accounts the results will be even more spectacular. Similarly, China recorded its second larges Trade Surplus on record. So global imbalances are as large as ever. The only question is: how will this be fixed? The Plaza Accord led to the bubble economy in Japan via very, very low domestic interest rates, a subsequent economic crisis when the bubble burst and a long, slow economic recovery. And with USD/JPY substantially lower than Pre-Plaza the U.S. still hasn't got anywhere with its Trade Deficit. In fact things are now worse.

Indeed, U.S. economic fundamentals are unimpressive all round. Yesterday's FED's Beige Book was similarly uninspiring. Though there was no sign of a uniform slow down in activity, except in the Residential Housing market, which is in trouble pretty much across the country. It is the bursting of the Housing Market bubble which is keeping analysts up at night. Given that the boom in the residential housing gave a huge boost to economic growth in the first part of this decade, it is fair to assume that the bursting of the housing bubble will resonate for a while. That's what everyone is waiting for. Talk of RECESSION has eased somewhat recently, but market watchers are STILL waiting for second round effects.

Yesterday's Trade numbers took the edge off the USD but the market remains broadly bullish USD. The focus, of course, is interest rate differentials and low volatility. The whole Carry Trade phenomenon needs low volatility to continue. If that cracks, and let's face it it has cracked in other markets, then all bets are off. The Carry Trade favourite, USD/JPY looks like it will be capped below 119.80. This morning BoJ officials helpfully suggested that the official cash rate has room to move higher before the end of this year. EUR/JPY is playing around with record highs but keeps seeing good offers above 150.00, so sell the rally remains the way to go. EUR/USD, despite the positive economic fundamentals in the EuroZone and the constant hints of higher rates from Trichet and his buddies, is struggling to make gains. Some of this is related to EUR/JPY selling by Central Banks but ultimately, the EUR/USD bull run will be part of the USD bear story. Unless the EUR/USD sustains a break below 1.2500 a buy the dip strategy is recommended.

OIL 58.87
GOLD 586.20

The correction in the GOLD price longed for by the USD bulls appears to be over. With China currently sitting on USD 988 billion in Foreign Exchange Reserve (and rising) and looking to diversify away from the USD, particularly given the pressure coming from the U.S. for a Chinese currency revaluation, the upside potential for GOLD looks strong. According to some reports the proportion of reserves held in GOLD by Central Banks is around 9% of total reserves, with China and Japan holding considerably less than 9% of their reserves in GOLD. A real shift towards holding GOLD as a reserve asset, even without a substantial USD depreciation, would light a fire under GOLD. For now, GOLD is still in range trading mode, albeit with a bullish tone. A sustained break above USD 600 would be positive for the market.

OIL remains bid on the back of rumours of OPEC agreements. Indeed, the whole Commodity Market sell off appears to be running out of steam. We have triggered the stops and seen a healthy correction, provided growth remains relatively strong in Asia and the EuroZone, then Commodity price gains are possible from here. The U.S. economy may be heading for recession but the spill over effect on other economies, thus far, has been limited.

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