Friday, July 07, 2006

Bad NFP Kill Hopes of USD Rally

EUR/USD 1.2850 / 53 Hi 1.2865 Low 1.2766
USD/JPY 113.91 / 95 Hi 115.31 Low 113.90

The market was looking for an increase of 175k (with rumours of a lot more) and got 121k. Another disappointing number in the series. The picture of weak economic activity in the States is starting to add up to more than just a temporary blip. Pre-release market chatter was all USD positive. This was more a result of the hope that the recent USD bounce back, in line with the bounce back in Stocks, could be the start a new medium term trend. A flimsy hope based on a flimsy premise.

All the USD fundamentals look poor right now.

The FED may well be forced to continue hiking rates to fight the inflation bogey-man (read fear of the price whiplash likely if the USD takes a dive) but the FED is not the only major Central Bank hiking rates right now. So the interest rate differential argument in favour of the USD is gone.

And that doesn't leave much else that is USD favourable.

Stock Market bulls will try and make the case that today's poor data will see the FED pause. And hey if you have a pause in interest rate hikes then that must mean there is something to celebrate. Right? Well you can make that case. But it's a fairly weak one. If the FED is pausing (and let's face it there hasn't been a pause yet - and it's been a while) because the economy is in trouble, then maybe the longer term outlook for Stocks is not that great.

Oil 75.65
Gold 632.80

Meanwhile it looks like OIL can reach 80 in less than a month and there is no reason to believe that the rally in OIL prices is anywhere near over. For GOLD and OIL to stage a serious reversal there would be need to be a serious shift in fundamentals.

In the case of GOLD the world would need to be more comfortable holding paper money than it is now. But with confidence in Governments falling, particularly global confidence in the competence of the current U.S. Administration, the chances that the attraction of holding little bits of green paper will increase any time soon are slim.

As for OIL, well you only need to think Middle East to wonder if the DOOMSDAY CROWD are onto something, so unless all the simmering conflicts and outright wars are dealt with in short order, there is no reason to believe that the price of OIL is likely stage a major reversal.

End of week and the USD downtrend has resumed.

It will be interesting to see if the BoJ bites the bullet next week. The pressure on the BoJ from the Government and the Business Sector has intensified. So the wrestling match isn't over yet and it's too early to say that a rate hike is a "fait accompli" in Japan. One thing's for sure though, a rate hike in Japan could really get the USD/JPY bear trend into gear.

Thursday, July 06, 2006

No Rate Hikes in Europe but the Writing is on the Wall

EUR/USD 1.2750 / 53 Hi 1.2784 Low 1.2717
USD/JPY 115.17 / 21 Hi 115.75 Low 115.12

No rate hikes were announced in the Euro Zone, Japan or the U.K. today, but Central Bankers leave little doubt that higher rates are on the cards. In Japan hints were made that a rate decision will be made as early as next week. While in the Euro Zone The President of the ECB, Trichet, pretty much outlined the case for at 25 point rate hike when the bank reconvenes on August 3rd. Central Bankers are talking Oil Price Shock and containing second round price rises. This fear of inflation means that the trend towards higher rates is far from over. Something Trichet has made abundantly clear.

Signals out of Japan are a bit more confusing, but no-one thinks the next move in rates will be down. So it's just a matter of time and, unless the BoJ is freeze dried for eternity, the recovery in Japanese domestic demand and inflation means that a rate rise is necessary. Business leaders and the Japanese Government are keeping the pressure on the BoJ to leave well enough alone and, given the Japanese cultural commitment to consensus, this makes clear cut policy decisions tricky.

But the clock is ticking.

Oil 74.90
Gold 629.00

Meanwhile back at the farm, OIL is breaking out to the upside with a target of USD 80 likely to be reached within weeks. Non-Farm Payroll Data is due tomorrow and markets are a chatter with the possibility that the recent correction on Stock Markets was just another opportunity to buy. The idea being that if NFP is weak then the FED will pause, so you buy stocks, and if the NFP is strong then that points to a strong economy, so you buy stocks. Which would be nice. A stock market rally would certainly help the people in Hedge and Mutual Funds recover some of their recent losses.

Unfortunately NFP may not really be such a big deal and certainly is unlikely to provide the market with clues about direction. As always watching what's happening on FX markets is far more important.

If the Dollar goes up Stocks are likely to follow. A stronger dollar means currency flows (speculative or not) are continuing in favour of the buck and this would keep creaking world markets ticking over. So thank God for cheap money (and hedge funds and leverage) while you can get it. But keep an eye on the buck. Should sad things start to happen to the dollar then rush to the exits while there is still time. We haven't seen the end to risk adjustment quite yet.

As soon as carry trades start to look like yesterday's garbage, we have trouble.

Wednesday, July 05, 2006

N.Korea fires up Gold but not the USD

EUR/USD 1.2752 / 55 Hi 1.2839 Low 1.2742
USD/JPY 115.12 / 16 Hi 115.26 Low 114.58

If you needed any proof that the USD's days as a global reserve currency are over you only had to watch market activity today. Gold shot up on the news that the North Koreans were taking pot shots with their missiles but the USD hardly budged. Gold as the global reserve of choice is back in vogue.

And while the U.S. continues to run a huge external deficit, an out-of-control Federal Government Deficit and an incredibly unpopular Foreign Policy (unpopular that is practically everywhere on the planet except Washington), the chances that foreign confidence in the USD will spontaneously recover are virtually nil. Unfortunately the ease with which the U.S. attracted foreign capital inflows in the past means that policy makers don't understand just what the shift away from the USD as a global reserve currency will mean for the U.S. economy. The lesson is likely to be a painful one.

Action is needed.

If the U.S. wants to stop relying on the kindness of strangers it has two choices: it can either increase domestic savings or it can reduce domestic spending. Otherwise it will continue to be at the mercy of the people with the spare cash. And who are those people ? Well, for instance Foreign Central Banks located in not so U.S. friendly places - like Russia and China - and Foreign Investors with lots of spare OIL MONEY, and the U.S. hasn't exactly endeared itself to the people of the Middle East lately. Only the Policy Wonks in Washington don't seem to be in the loop on that issue. Maybe if they stopped spying on U.S. citizens and started reading some foreign news media they might get the general idea.

Let's assume that the U.S. is going to continue losing friends in the wider world, this puts the USD at risk and it needs to do something about its external funding requirement. That is, it needs to reduce it. Fast.

So what are the prospects for generating increased savings and/or reduced spending in the Government sector?

First, there is a (losing) war in Iraq and Afghanistan to finance. Second, there is a Presidential election around the corner and the electorate is not happy. Right. So there is no chance that any progress in reducing the Federal Government's dependency on foreign capital will be made in the short to medium term.

That leaves the Private Sector.

Right. So what does that mean? Well the Government is not keen to curb Private Sector Demand with targeted Tax Hikes or Government Spending Cuts. But there is another policy option.

Interest Rates.

If the FED keeps hiking they just might save the USD. There is no chance they can save the Stock Market. If the FED doesn't keep hiking then it risks a USD collapse. And the Stock Market goes anyway.

Tuesday, July 04, 2006

Quiet day on the markets

4th of July holiday. Volume was low and FX trading range bound. But FX volatility hasn't gone away, it's just skulking in the background.

Potential for market volatility is sky high.

You only have to look at the recent very hairy roller coaster ride on 1) Emerging markets (Turkey, Hungary, Iceland) and in 2) Commodities (Gold, Copper, Zinc) and 3) Stocks to know that all is not well out there.

Market leverage has grown exponentially over the past decade and that leverage means volatility is here to stay. The impact of increased volatility on the Real World Economy will ultimately be brutal. The powers-that-be are apparently confabulating behind closed doors about how to address the problem.

Let them confabulate. But it's a bit late. The genie is well and truly out of the bottle.

There are rumours about the existence of a mythical PPT (Plunge Protection Team) and hopes that the PPT will emerge from the shadows if anything goes seriously wrong (in the United States that is) but no-one really believes that the PPT or anyone else can stand in front of a market Tsunami.

And things can go wrong.

The big question on everyone's mind is how safe is the dollar and by extension the current global financial system. After all when you use the USD as your global reserve currency and the fundamentals behind the USD are looking shaky as never before, then your global financial system just might have a problem.

That certainly seems to be the concern of the big boys at the BIS (Bank of International Settlements).

This being the case it seems fair to ask if the recent financial market volatility was just a dress rehearsal for the big one.

To be cont.

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