Friday, July 14, 2006

While FX Ponders Stock Markets Panic

EUR/USD 1.2673 / 76 Hi 1.2699 Low 1.2648
USD/JPY 115.75 / 79 Hi 116.20 Low 115.32
EUR/JPY 146.70 / 74 Hi 147.21 Low 146.35

While Stock markets stumble the world of FX is strangely quiet. The much-anticipated BoJ move had no impact. What a surprise, not. And while all hell breaks loose in the Middle East the FX markets remain range bound. The quiet before the storm? Nostalgia fans have bid the USD mildly higher. Well it was the Global Reserve Currency after all. But the USD up move lacks conviction. I guess we have to wait for the G8 to announce it would like to see a lower USD (they could disguise the statement as a call for stronger Asian currencies - but it's the same deal) before we see any real USD selling.

Meanwhile the Israeli attempt to start WWIII seems to be working. Only the unstated assumption that they have an American "blank cheque" (now where have I heard that expression before?) is allowing this to continue. And the U.S. (where the crazies are in charge) has been making all the right noises to reassure Israel that in fact it does have its full and unqualified support. The whole world is on the edge of its seat and America is making goo goo noises to Israel?

And I love the way the American press is on board on this one. An article in The Washington Post today talked about Israel being "attacked". Last time I looked a couple of Israeli soldiers had been kidnapped and were being held hostage in attempt to force Israel to release prisoners it has been holding since the beginning of time. Does the expression "disproportionate response" mean anything to you, Mr Oren? No, I guess not, so lets just prepare for war.

The guys with the big guns are already looking for ways to extend this conflict by openly suggesting that the kidnappings were sponsored by Iran. I guess we'll just have to take their word for it. Hey maybe these guys also have WMDs. And if our fighters for democracy don't find any when they invade the country, no matter, at least they'll have brought democracy. What's that? They already have democracy. Yeah maybe but it's not the kind of democracy we want so it doesn't count. Plus these guys have oil.

All those songs about no more war and here we are. (The Russians may very well love their children too but do the Israelis?)

Makes you wonder what's gonna happen with 'Make Poverty History', doesn't it? Let just hope they don't suddenly start a campaign to wipe out disease too. Next thing you know we'll all be struck down by plague.

But no matter there is a G8 scheduled this weekend so our fearless leaders will get it sorted. Ha. Ha. Right. So maybe we all better panic. At least that would be realistic. What's the expression? Oh yeah, don't panic but if you do panic, panic first. And we have all the right ingredients for panic: leverage, lots of it, cheap money, a geopolitical mess, speculators on every corner, derivatives from outer space, and now - NOW!! - EU leaders (you gotta love their timing) are making noises about easing up regulations on Hedge Funds. I'd like them to explain that little policy back flip to their constituents when this is all over. (Oh they funded your campaign? I see. Well that's all right then.)

There is, of course, something that the rest of the world can do about this mess. But it would take balls, co-ordination and the conviction that the U.S. (and by extension Israel) has to be brought to heel fast. The U.S.'s Achille's Heel is its external funding requirement. All it would take is the Central Banks of the world to announce their intention to sell USDs in concerto (remember what happened to GOLD when the CBs were unloading?). These guys may be crazy but they understand money. Of course there would be a cost. The question is which strategy would cost more: Blah, blah, blah and hope for the best or shoot first and ask questions later? The world has a choice either it keeps financing the U.S. war machine or it doesn't.

Either way stocks are still in trouble.

Next week we have Bernanke's testimony to look forward to. And with his current track record (and the beard doesn't help) that should be good for the fans of volatility.

OIL 77.28
GOLD 661.80

Geopolitics means the USD 80 is just a couple of weeks away for OIL. Interesting how Mr. Rupert Murdoch suggested that the Iraqi war would be good for the world economy because the oil price would go to USD 20. The world waits with bated breath for Mr. Murdoch's next forecast. I guess USD 100 is now not out of the question.

GOLD may be subject to volatility but the trend is your friend. And the trend is pointing up. It may take a while to test recent highs, but that's where we are heading. Buy on dips. Or just buy.

In closing I would just like to point out that Iran has a population of nearly 70 million people, a quarter of whom are under the age of 15. All the 'Christian' right-to-lifers might just like to ponder those numbers (and the Iranians right-to-life) before they give the OK for an attack on another sovereign nation.

Oh and if that doesn't clinch it then join the dots on what more conflict will do for the oil price.

Thursday, July 13, 2006

When Real Leadership is Needed it's Nowhere to be Found

EUR/USD 1.2686 / 89 Hi 1.2733 Low 1.2684
USD/JPY 115.46 / 50 Hi 115.53 Low 114.99
EUR/JPY 146.49 / 53 Hi 146.85 Low 146.25

Suddenly the world is crowded with BoJ doubters. Will they after all? And so the scramble to exit short USD/JPY positions propelled the USD a little higher yesterday. Tomorrow the question will be answered and we can get back to the real world. Which will be a relief. Those keen to short the JPY should pause to reflect a little on current fundamentals and they are not exactly USD positive right now. USD strength continues to represent a selling opportunity.

Nasty news, market jitters and a leveraged market have seen global Stock markets take a tumble. A weak performance in Japan pre-BoJ and post-Bombay bombing, the failure of the U.S. market to extend its two day rally, the spike in OIL, the crisis in the Middle East and expectations of tighter monetary conditions world wide all make for a stock market unfriendly world. Further weakness looks likely.

Indeed, selling pressure could accelerate as the Geopolitical situation deteriorates. And there isn't a cool head in sight. While Israel escalates its full-scale military assaults on its neighbours, world leaders are planning their Summer holidays or giving out medals to football players. Except at the White House, of course, where spokesmen are helpfully suggesting that the real trouble makers in the region are Iran and Syria. In fact the White House is now holding Iran and Syria "responsible for.... the ensuing violence". So I guess the Red Card should have gone to Materazzi.

And Iran has just been referred to the U.N. Security Council (the vote was last night).

This is not looking good. Unless you think that increased violence is a good thing because it gives a chance to the guys with the biggest guns (and we know who they are, don't we ?) to seize more land (or oil wells) and take control of larger parts of the globe. There have been hints that this just might be the game plan. If that sounds crazy, it's because it is. But that doesn't mean it isn't happening.

So the long, hot Summer continues. All the politicians with an ounce of sense are sitting it out on the sidelines and hoping that the whole situation just goes away. Which is a good strategy if you are clueless. But the results might be disappointing.

OIL 75.77
GOLD 653.20

More trouble in the Middle East, weak oil inventory numbers in the States and reports that Nigerian pipelines have been attacked have seen OIL break through record highs. It was not a spectacular move, but more upside is expected.

GOLD, of course, has been the major beneficiary of increased global tension and unrest. The uptrend continues and falling global stock markets is only going to increase safe haven GOLD buying. In a world of uncertainty very few alternatives look attractive.

Wednesday, July 12, 2006

The Best Case Scenario

EUR/USD 1.2703 / 06 Hi 1.2780 Low 1.2684
USD/JPY 115.37 / 41 Hi 115.54 Low 114.16
EUR/JPY 146.56 / 60 Hi 146.72 Low 145.76

The Bush Administration managed to get itself some positive headlines recently by bellowing about a 30 percent reduction in the projected Federal Government Deficit. The bottom line is that the deficit in 2006 will be USD 296 billion on current projections compared to USD 318 billion last year, hardly a breathtaking result. The old trick of following up ugly forecasts (USD 423 billion) with surprise improvements seems to be working. This tired tactic has been used over and over with regard to the Federal Government Deficit. And it works every time. Short attention spans on financial markets and in the media can be useful. No-one with a frontal lobe which is still operative should take the slightest notice.

The Bush Administration still faces a lot of hurdles and careful management of financial market expectations will be required. Henry Paulson will need all his market savvy. The U.S. currently has to deal with a massive external funding requirement, an over-indebted Consumer Sector, rising rates, a very green Federal Reserve Bank Governor and a hostile wider world. In this environment a lot needs to be achieved.

The Best Case Scenario would be if a gradual, steady USD devaluation could be managed. This would allow the U.S. to correct its external deficit over time. In essence U.S. imports would fall and U.S. exports rise as the USD devalues. At the same time the U.S. could wean itself off its long running dependence on the foreign capital inflows needed to finance current consumption. In this benign scenario the relentless rise in the FED FUNDS rate would come to an end sooner rather than later, as inflationary threats would be contained. A gradual USD devaluation would ensure that the impact of imported inflation on domestic CPI would be modest.

Today's U.S. Trade numbers show the necessary USD devaluation is nowhere near over.

The adjustment process could also turn out to be rather painful. The Worst Case Scenario would centre around a sharp fall in the USD together with a run on U.S. assets as foreign investors rush for the door. This would force the FED to either hike rates aggressively as an emergency measure (not quite like Iceland or Turkey - but you get the idea) and to hold rates higher for longer, regardless of the (negative) impact on domestic economic activity. Treasury yields, which are to a great extent dependent on offshore investment inflows, would rise sharply and, with rates rising across the curve, the impact on economic activity could be devastating.

Either way the U.S. (and by extension the world) needs a lower USD. The question is can this be managed without causing massive dislocation in financial markets? It's a fine balancing act.

What we do know is that interest rates may be close to topping in Anglo-Saxon countries and the Euro-zone and the Japanese Central Banks have only just moved into hiking mode. Yesterday's decision in Canada to keep rates steady, and the CAD selling that followed, highlighted the potential risks for the USD in this environment.

OIL 74.44
GOLD 647.30

World leaders were hoping the G8 meeting scheduled this weekend would take place on a positive note, or at least with some sign of an opening in negotiations from Iran. That now looks unlikely. Indeed Geopolitics are back in the spotlight and there is no improvement in sight. Bombs in India and the Iranian refusal to respond to the EU's July 11 deadline saw GOLD spike higher, but everything else was eerily unmoved. Note there was little in the way of safe haven USD buying.

With the crisis in Gaza looking uglier every day and no sign of progress in Iraq, this Summer is unlikely to provide the kind of calm the Goldilocks team needs. Any kind of weakness in the putative World Reserve Currency (the USD) will see the shift into GOLD continue. Buy GOLD on every dip (provided you have deep pockets and a long term investment horizon) and sell the USD on every rally. And remember the keywords for today's markets: volatility, volatility, volatility. This is not a market for the faint hearted or tight stops, unless you like seeing them triggered.

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Tuesday, July 11, 2006

Dead Calm on FX Markets but Equities Look Vulnerable

EUR/USD 1.2724 / 27 Hi 1.2756 Low 1.2705
USD/JPY 114.54 / 58 Hi 114.70 Low 113.92
EUR/JPY 145.77 / 81 Hi 145.88 Low 145.17

FX Markets looking for direction keep focusing on the BoJ, which may move to hike rates Friday. Quite frankly: who cares ? The move, if it comes, has been fully factored in and isn't going to add anything to what is already known. Deflationary pressures in Japan have subsided and domestic demand has shown signs of recovery. As a result it is only natural to expect a return to normal monetary policy, which means that rates will have to move up quite a bit from current levels (say to 1.0 - 1.5%) if, and it's a BIG if, economic recovery continues at its current pace. The only surprise would be if the BoJ decides to sit pat Friday. Not that such a decision would change the lay of the land. It would only prolong the agony. Waiting for the BoJ is starting to feel a bit like waiting for Godot, and market anxiety surrounding this non-event is only slightly less absurd.

For now the FX market is stuck in range trading mode and waiting for a catalyst. The chances that the catalyst will be the BoJ decision Friday are negligible. Stock market action, though, bears watching. A break out on the stock market will either send the whole market scrambling to exit positions and cover risk (as we saw in May) or see a return to Goldilocks Nirvana. Goldilocks Nirvana though has been done to death. The risk for stocks remain to the downside.

And if Stocks take a hit so does the USD.

Insanely good Alcoa numbers released yesterday were considered disappointing by a hyped-up market. If market reaction to the numbers are anything to go by then the market is setting itself up for further disappointment. U.S. economic stats clearly point to a slow down in activity across the board. After 17 un-interrupted rate hikes, that is hardly a surprise. Particularly when you consider that the most recent U.S. economic expansion was built on cheap credit and the willingness of the U.S. Consumer to shoulder increasingly large debt burdens. As the cost of servicing that debt rises the pain in Consumer Land (and Real Estate Land) can only increase. Sooner or later results from Corporate America are going to reflect this changed economic landscape and less than stellar numbers this quarter should not come as a surprise.

Oil 73.98
Gold 633.50

OIL is holding at high levels but there is not enough anxiety in the market, or enough strong economic activity out there, for a break through recent highs. GOLD has seen a small rebound but any further moves will depend on the USD. Any sustained USD weakness will only increase the shift away from holding paper money by Central Bankers and strengthen the case for GOLD. The outrageous levels of leverage and speculation in both these markets mean that volatility in GOLD in particular is way out of proportion to changes in underlying fundamentals which means that taking positions is only for those with very deep pockets and a long term investment horizon.

Monday, July 10, 2006

USD Recovers as Stocks Rebound and Excuse me but your Yield Curve is NEGATIVE

EUR/USD 1.2731 / 34 Hi 1.2820 Low 1.2721
USD/JPY 114.12 / 16 Hi 114.28 Low 113.44
EUR/JPY 145.25 / 29 Hi 146.14 Low 145.01

The Japanese Stock Market ignored both the weak performance on Wall Street Friday and the rumours that the BoJ stands ready to hike rates in the short term (possibly as early as Friday this week). The focus of the market was instead on strong underlying fundamentals and the Nikkei closed up 1.6 percent. A positive open on Wall Street helped European markets bounce back from early weakness and the underlying tone of European markets remains positive. Leaving aside the possibility that global stock markets take a dive, the only major shadow overhanging European markets is the threat that European rates will move higher on August 3rd.

The outlook for higher rates in the Euro Zone wasn't enough to push the Euro/USD higher today, and with EUR/JPY near record highs, strong selling pressure on the crosses is likely to keep the Euro rally in check in the short to medium term. Before the Euro/USD can make further progress to the upside the USD/JPY has to see further weakness. Essentially the USD/JPY has to lead the USD bear trend from here on in. So the focus is back on the USD/JPY and a possible BoJ move Friday.

One way or the other, the markets need more information to break out of ranges. With trading volumes fading as Summer approaches, even rate hikes may not be enough to see the market sit up and take notice. Quarterly earnings results though could end up being the catalyst for a break out. The market is anticipating strong results in the States, and if we actually get good numbers, this should support the case for a short term USD rally. If results are weak , however, the recent reassessment of underlying fundamentals, which saw position squaring lead to a sharp correction, could be repeated.

Oil 73.48
Gold 627.20

Profit taking from record levels saw OIL prices soften and the modestly firmer USD also saw GOLD prices fall slightly this morning. No major news, no major short term trend and, like FX, these markets remain in a holding pattern.

One point of note: the U.S. Yield Curve is now clearly NEGATIVE (ie. the FED FUNDS rate at 5.25% is higher than both the 30 year Treasury yield at 5.19% and the 10 year yield at 5.15%). Negative yield curves normally point to economic slow down and a bear market in stocks. So far no-one seems to have noticed.

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