Tuesday, November 07, 2006

Debt Financing in a World of Rising Rates

EUR/USD 1.2810 Hi 1.2820 Low 1.2720
USD/JPY 117.33 Hi 118.35 Low 117.25
AUD/USD 0.7755 Hi 0.7761 Low 0.7701
EUR/JPY 150.35 Hi 150.60 Low 150.16

Interest rates again: some noises out of the BoJ concentrated minds on financial markets. The BoJ is gearing up to raise borrowing costs. The ECB is gearing up to raise borrowing costs, with more increases predicted for 2007. The BoE is expected to raise interest rates this week and that move won't necessarily be the end of the cycle because Credit Growth in the U.K. is still out of control, Housing Prices are rising and the BoE is not happy. The RBA is expected to bump up interest rates some time soon, despite the drought, expectations that the Commodity Prices may have peaked and the very high level of Household Debt to Disposable Income in Australia.

Meanwhile the FED is still in PAUSE mode and despite some vaguely positive NFP numbers Friday, well the Unemployment Number fell which is something, the overall picture of economic health in the United States is not generally as positive as the Dow Jones, President Bush and his lackey, Henry Paulson, would have you believe. Indeed, a number of commentators have suggested that GDP numbers for the Third Quarter overstated growth by quite a bit.

Some suspect shenanigans involving Motor Vehicle Output, which added 0.72% to overall GDP growth in the quarter, in spite of the fact that New Car Sales actually fell quite sharply. Depending on which survey you look at Motor Vehicle Sales either fell by 11% or by 7.6% over the quarter. So Output was UP but quite a lot of Inventory must have been produced and little else. Nobody was ACTUALLY buying those New Cars. In addition, there have been rumours and murmurs about the GDP Price Deflator, which fell from 3.3% in Q1 and Q2 to just 1.8% in Q3. Without that fall GDP growth would have been FLAT for the quarter. Hmm. Not everyone believes that the fall in the GDP Price Deflator can be justified.

Add these two factors together and GDP numbers are more likely to be revised DOWN than UP. So growth for the quarter, in the final analysis, is likely to be lower than the already poor 1.6% annual rise recorded. While you can massage the data for a while (electoral necessity and all that) eventually the TRUTH will out.

What we do know is this: the U.S. economy is an economy which depends to a very large extent on the easy availability of credit. Without easy money both the Federal Government and the average U.S. Consumer will have to cut back. Debt financed economies will suffer as the cost of debt financing goes up. That's a pretty simple, straight-line correlation. And so to expect U.S. growth to continue unimpeded as the cost of debt rises (note what world Central Banks are doing RIGHT NOW) is probably not the right view.

And that's without even considering the fall out from the implosion in Residential Real Estate which is currently taking place in the States.

USD short covering post NFP seems to have run its course. We are back to fundamentals and the USD fundamentals are poor. China, which is holding ever more foreign currency in its reserves, recently made the point that the problem as such is not that the Remnimbi is undervalued. No. The problem, according to the Chinese, is that the USD is overvalued against most major currencies. Now you may argue with the vested interests of the Chinese but its hard to argue with their conclusion.

This point of view does seem to becoming, well, pretty well accepted. So, it's back to selling the USD on any sign of strength and wondering when the whole thing is going to crack.

OIL 59.95
GOLD 629.70

OIL is holding just under USD 60,00. Which may or may not make Mr Joe Average relaxed and comfortable. What we do know is this: unless world growth comes to crashing halt there is not much scope for further falls. So whatever deal Bush may or may not have made with his Saudi allies, whatever the state of the U.S. economic slow down, unless growth in Europe and Asia come to a dead halt the price of OIL is more likely to go UP than to fall.

And GOLD simply remains the ANTI-DOLLAR at a time when being ANTI-DOLLAR is very much flavour of the decade. Now whatever happened to the Gold Cartel? I guess there are only so many balls which you can keep in the air at any one time and, as every good trader knows, you just don't stand in front of moving train.

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