Friday, July 21, 2006

Life in a Parallel Universe

EUR/USD 1.2680 / 83 Hi 1.2691 Low 1.2624
USD/JPY 116.10 / 14 Hi 117.15 Low 115.82
EUR/JPY 147.20 / 24 Hi 147.88 Low 146.85

In the parallel universe where all our politicians live, the United States which has openly been arming and financing Israel for decades, has no real control over the actions of its ally. The most that the Bush Administration can do at present is call for restraint. So far that restraint has resulted in the displacement of more than one quarter of the Lebanese civilian population, destruction of much of Lebanon's infrastructure and the killing of more than 300 Lebanese civilians. There will be more. On its other border, Israel is still holding the Palestinian Government M.P.s (that it kidnapped) hostage. No problem.

Meanwhile Iran who, according to Washington intelligence sources (yes them again) has been funding Hezbollah, can control Hezbollah at whim and have so far failed to do so. The result being that the two Israeli soldiers who Hezbollah kidnapped are still captive and around 30 Israelis have been killed, as Hezbollah continues to shell Israel from Lebanon. This shelling, in response to the Israel attack on Lebanese infrastructure has had, so far, nothing like the devastating impact that Israel has had in Lebanon.

No matter. Iran should control Hezbollah. It has not done so. Obviously Iran needs to be taught a lesson.

But wait there is more. Israel has issued orders that all civilians should leave Southern Lebanon. Troops and tanks are being amassed at the border with Lebanon and an all-out assault and invasion is just days away. Washington is standing by to welcome this new liberation army and proclaim the democratic government of Lebanon safe and sound.

What we have here is big time escalation.

Israeli will occupy Lebanon. And Syria and Iran have had too much air time from the likes of George Bush and Tony Blair not to be the next targets. Syria might be small bananas but Iran is a big target with large oil reserves. It also has a large civilian population and, given the disastrous invasion of Iraq, there is no way the U.S. administration can contemplate an invasion without a "pre-emptive" extensive and destructive bombing campaign.

Basically the Middle East is going to hell in a hand basket and nothing and nobody can stop it. That is, everything is going to plan. We just aren't privy to that plan. All we can do is watch what the mainstream media is telling us, listen to the spin and connect the dots. The dots are bad.

Ben Bernanke meanwhile is living in an annex of that parallel universe. It's a nice place with no dangers. In there Oil will remain steady. Futures tell us so. Inflation will be contained and even fall. Growth in the States will moderate, but continue. And offshore investors will continue to supply the U.S. with all the funds it could possibly need.

Financial markets, however, have stopped listening. Bernanke said PAUSE and the FX market said SELL. The USD is getting hit and more selling is likely. USD global reserve currency? I don't think so. Not while the nutters are in charge.

The prospect of an all out war in the Middle East sometime soon is also not doing a lot for the Stock Market. Although Bernanke doesn't see any risks out there, the rest of the world is not so sure. Slower economic growth in the States is going to hit profits at the same time when GEOPOLITICS is written in capital letters in every sane mind on the planet. It's an ugly combination. The outlook for stocks remains poor.

OIL 75.00
GOLD 635.00

OIL unsurprisingly remains bid. GOLD is seeing volatility but more ugly fighting in the Middle East, with the sure fire possibility of more to come, means that GOLD too will remain bid.

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Thursday, July 20, 2006

Bernanke the Dove Saves the World

EUR/USD 1.2626 / 29 Hi 1.2632 Low 1.2587
USD/JPY 116.69 / 73 Hi 116.93 Low 116.54
EUR/JPY 147.35 / 39 Hi 147.40 Low 146.97

Ben Bernanke just changed the world. At least that's what financial markets seem to think. His dovish comments yesterday came at a time when the market was expecting hawkish guidance. They didn't get it. And timing is everything. While the market sits back and rethinks the chances of an August 8 rate hike in the States, it's worth taking a look at what Bernanke actually said.

First, he noted that a moderation in economic activity is under way in the States. After 17 rate hikes and counting, that is hardly a surprise. Second, he noted that even if inflationary pressures continue, weaker domestic economic growth should see inflation contained in the medium term. Third, he noted that the second round inflationary pressure, namely rising wages, would likely be absorbed by companies, given that softer demand would not allow price rises.

What he is saying is that while profit margins are now high, they will be eroded by rising wages and weaker growth. Bernanke is not only calling the peak in rates and economic activity but in profit margins. Stocks missed that.

While it remains to be seen if softer demand can do the job the FED won't, namely contain inflation, what Bernanke did do is open a window of opportunity for USD bears. And they took that opportunity.

But the USD and capital flows were ignored by Bernanke. Bernanke's assessment focused almost exclusively on domestic factors. The U.S.'s very large external deficit figured nowhere. And the Federal Government Deficit also didn't show up on his radar. So the two greatest risks to growth in the U.S. were absent. This is not a good sign. The U.S. is not a nation which can tranquilly assume that offshore capital inflows, necessary to fund domestic consumption and the massive Federal Government Deficit, are a given. It can not assume that a substantial USD sell-off, and resultant inflationary consequences, is not a risk.

Bernanke is factoring in the best of all possible worlds: inflation contained by softer domestic demand, oil prices which remain steady, wages pressures absorbed by companies, a steady inflow of offshore capital and plain sailing on FX markets with USD fluctuations having no impact on inflation or Treasuries. It is in that environment, and only that environment, that the FED can afford to hold a dovish view.

For now the market is buying the best of all possible worlds scenario. But it will take only one shock to wake them up. We have a lot of potential shocks out there: the Middle East (Iraq, Iran, Lebanon, Israel, Syria), and Oil to name just two.

With the Bernanke FED unlikely to hike rates steadily, the USD sell off is expected to continue with the USD/JPY leading the charge, given the current stratospheric level of Eur/JPY. Stock market bulls will have to hope that USD selling does not scare stocks. Longer term, however, that is the big risk. Bernanke has not changed the world he has just given the market a very benign assessment of current risks.

OIL 72.87
GOLD 643.00

Bernanke was also rather dovish on the OIL outlook. Taking his cue from futures markets, he suggested that future OIL price rises are not expected to be substantial. If this is his assessment of commodity price risk and the associated inflation risk, then we are in trouble. Anyone who assumes that futures predict the future obviously hasn't ever traded futures.

GOLD is still on a winning streak and given the type of economic land political leadership coming out of the States at the moment, it seems fair to expect that trend to continue.

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Wednesday, July 19, 2006

Inflation Sneaks Back but will Bernanke Care ?

EUR/USD 1.2476 / 79 Hi 1.2512 Low 1.2458
USD/JPY 117.71 / 75 Hi 117.91 Low 117.19
EUR/JPY 146.86 / 90 Hi 147.13 Low 146.30

The New York Times reported today that the U.S. is waiting before it does anything about the Israeli offensive under way against Lebanon. Another 7 days or so of Israeli bombing to 'establish a buffer zone' and then the U.S. will apparently do something. Sending Condoleezza Rice in seems to be the extent of the "do something" plan. No mention that Israel's actions are illegal under international law. The Financial Times reports that Israel has already done an estimated $2 bn worth of damage to Lebanon's infrastructure. So I guess when this "offensive" (isn't that the perfect word) is over Lebanon will sue Israel for war reparations. And win.

At least we now have a time frame: 7 days. So if you ever stopped to wonder who is holding the remote on this conflict, you can stop wondering now. As soon as Israel gets the U.S. say-so it will stop bombing and move to the negotiating table.

After which it is expected that the three Israeli soldiers who are currently being held in Lebanon and Gaza will be released. Well maybe not. But in any case, with the excuse of the hostages, Israel will be able to reoccupy territory in Lebanon and Gaza indefinitely. Mission accomplished. Don't expect negotiations to start until after Israel has achieved its buffer zone.

Meanwhile data out in Great Britain, New Zealand and the United States all point to higher levels of inflation than markets had anticipated. The next big question being: will we continue to see rate hikes in Anglo-Saxon economies after all?? This news has seen recoveries in the USD, the NZD and the GBP. The carry trade may not be over yet. The idea is that, despite signs of slowing economic activity, inflationary pressures will continue to force the hand of Reserve Banks everywhere.

Stock markets seem to be taking all the negatives with relative calm. The Bernanke statement today will be the next test for the market. And Mr. Bernanke will have to tick a lot of boxes: yes the FED is aware that in some areas economic activity has shown signs of moderation but no the FED is not on the back foot when it comes to fighting inflation (and supporting the USD). The pressure will be on and Bernanke's only out will continue to be: the data, the data, the data. "We don't know how the data will pan out so we can't decide our next move already".

Should Bernanke come across as dovish on inflation and more concerned about levels of domestic economic activity today's testimony will define his mandate. Stocks will respond accordingly and only when and if there is a backlash in either the currency or Treasury market would there be negative repercussions for the Stock Market.

Oil 73.47
Gold 631.50

Dithering in commodity markets continues. But you only have to watch Nickel to know that the speculators are still out there in full force. If Bernanke's Testimony today begins a new USD down move, then commodity prices can be expected to recover accordingly. Volatility is sky high though and whiplash trading will continue.

If we really do have a return of inflation and Bernanke and his boys are happy to wait it out and see how past rate hikes impact on activity going forward then the case for higher commodity prices has been made. No question.

Tuesday, July 18, 2006

Assume Crash Positions Please

EUR/USD 1.2537 / 40 Hi 1.2559 Low 1.2495
USD/JPY 116.92 / 96 Hi 117.24 Low 116.68
EUR/JPY 146.59 / 63 Hi 146.79 Low 146.22

In the current Middle East flare up it's hard to know what to count: the number of civilian casualties or the number of nuclear bombs currently sitting in the Israeli arsenal? Of course, now that the boys from the G8, the U.N. and the E.U. are on the case we have nothing to worry about. Just kidding.

Anyway we all know that we can trust the responsible people in Israel not to do anything too awful. Yeah right. So given that they have a blank cheque from W. and his cronies, and given that the U.N., the EEC and the Arab League are currently trapped in some kind of time warp we can all relax and enjoy the Summer. Meanwhile Israel has kindly suggested that the Lebanese civilians start evacuating and appears determined to occupy all of the territories which it recently withdrew from, and then some. Deadly Double Standards

Although the world is obviously in good hands, the Japanese stock market isn't looking all that relaxed and comfortable. The 2.75 % fall today came in spite of the signals from the BoJ that there will be no rush to follow up on the recent rate hike and confirms that the Nikkei is in a bear market. The U.S. market held yesterday but the bullish case for stocks looks more and more like yesterday's story. And selling pressure continues on European markets while emerging markets appear to have thrown in the towel altogether.

The outlook for global stock markets continues to be poor: tighter monetary policy is spreading like bird flu, oil prices are stratospheric, there is no government with a clear game plan for current economic and political difficulties/crises/etc. The U.S. is fighting wars in Iraq, Afghanistan and potentially (if the neo-cons get let out of their cages) with Syria and Iran. Prudence would suggest that risk reduction is the recommended strategy. The mega-prudent would do well to assume crash positions.

The USD is hanging in there, with the market hoping that the Bernanke testimony (which is now widely expected to be hawkish) and the escalation in the Middle East will spark more USD short covering and some old fashioned "safe-haven" buying. Short term this strategy might work, but no-one should mistake this for a long-term position. The U.S. is chronically in debt and dependent on foreign capital inflows. It needs to maintain offshore investor confidence in the face of policy strategies which seem misguided at best. Only confusion on financial markets and well placed media blurbs can keep the strong USD ball rolling.

Inflation and capital flow data out today will be poured over by analysts looking for clues about the direction of interest rates and the state of offshore confidence in the USD. Today's data really isn't so important. Longer term the writing is on the wall for the USD.

OIL 75.93
GOLD 648.10

Selling GOLD at the first hint that a ceasefire with Israel is possible is a misplaced strategy. The neo-cons in the U.S. keep beating the drums of war and are now openly suggesting that the U.S. move to "hit" Syria. This would open another front in the war on terror and would be a prelude to open hostilities with Iran, which seems to have been the real target all along. I guess there are people in the oil industry who never really got over the fact that the Iranians kicked out their boy the Shah. These kindly souls have a score to settle. A score they didn't settle when they armed Saddam and encouraged him to attack Iran in a bloody and futile conflict. So this Act II. Or III or something. Whatever.

The neo-cons must have missed the fact that the Bush Administration can't afford the war on terror that they are already running, that the U.S. electorate is unhappy and that U.S. "allies" are increasingly hostile. The only leader who still seems to be on board the Bush bandwagon is Tony Blair, and he has a whole line of snipers just waiting to shoot him down at the first real opportunity. Still the neo-cons are the only people on the scene with an agenda which is crystal clear. Which means odds are their favour.

Sell oil if you think that something will be done shortly. Otherwise don't.

Decisive action is needed if the current crisis is to be addressed and the chances that we can expect anything like decisive action soon are depressingly small. Unless, of course, your definition of decisive action is bombing Syria.

Monday, July 17, 2006

No News is Good News ?

EUR/USD 1.2523 / 26 Hi 1.2658 Low 1.2510
USD/JPY 117.17 / 21 Hi 117.32 Low 116.14
EUR/JPY 146.73 / 77 Hi 147.17 Low 146.48

The G8 provided the chance for our fearless leaders with a change of scenery and that's about it, really. Oh and it gave us a snapshot of just how disunited the G8 is on just about every issue you could imagine. There was no real guidance on the recent escalation in violence in the Middle East, except for a very weak 'please stop' to all those involved. There was no guidance on currencies, no guidance on world growth, world trade or in fact on anything meaningful.

More importantly there was no signal that recent escalation in the Middle East will be met by any kind of action by any major power. So there is no reason to expect hostilities to calm down on that account.

Perhaps the rise in the OIL price, which the escalation around Israel has created, is not wholly unwelcome. Russia, oil producers in the Middle East (who after all are not located in Syria, Lebanon or Israel), and America's oil millionaires are all raking it in. Which means the incentive for doing something about the increased violence, or the rising price of oil, isn't really there.

What's more in this environment rate hikes can be blamed on OIL, which is convenient. No need to mention policy failures in other areas and all of the negative economic consequences of rising interest rates can be blamed on "terrorists", who are foreign, elusive and unelected.

In a way it's almost a perfect set-up. Although not for the man in the street. But let's be honest, the man in the street is not making the decisions here and the most important thing for the people who do make these decisions is: how do you sell them to the man in the street? Rates may have to be hiked, not to save the USD or to compensate for incompetent fiscal policy, but because oil is increasing inflationary risks. And oil is rising because of those nasty, foreign terrorists. Perfect.

Policy makers in the States can hardly be unaware of the risks. Paul Volcker pointed out Friday that , because of U.S. dependence on foreign capital, "it is critical that we maintain confidence" in the USD.

The crisis in the Middle East has provided the USD with much needed safe haven buying, but we are not out of the woods yet. So financial market will be sifting through the tea leaves after Bernanke speaks Wednesday and, given the hints from Volcker and others, it's hard to believe that he won't make all the right noises about containing inflation.

The question of the quarter is: will stock markets be sacrificed on the altar of USD protection?

Oil 75.80
Gold 652.70

A stronger USD has seen profit taking in both the GOLD and OIL markets, despite the Middle East unrest. Volatility, as usual, remains the name of the game.

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