Thursday, August 31, 2006

Global Growth is Slowing

EUR/USD 1.2851 Hi 1.2864 Low 1.2816
USD/JPY 117.06 Hi 117.49 Low 116.95
AUD/USD 0.7635 Hi 0.7644 Low 0.7608
EUR/JPY 150.46 Hi 150.74 Low 150.16

First the good news: there is none. That was quick. In Japan all of the economic numbers released this week were bad. Today was no different. Industrial Production numbers for July fell 0.7%. The market had been expecting a rise of 0.9%. Similarly Housing Starts for July were down 7.5% (forecast +0.1%), Retail Trade and Household Spending were weak, and significantly below forecasts. But the market is not ready to give up on the Japanese Economic Recovery Story quite yet. Analysts are looking on the bright side: rates in Japan are now expected to remain on hold for the remainder of the year which is supposed to be good news because low rates stimulate demand (note rates in Japan have been zero FOREVER so the focus is misplaced) and domestic demand is now the engine of recovery, as if Japan had quietly transformed itself to a Demand-Led Economy, which it hasn't.

The Japanese industrial machine is export-orientated. The slowdown (sorry "softening") underway in the U.S. economy will hurt Japanese exporters and this will be bad for growth. This is now showing in the Japanese data. More bad news is likely.

The USD remains buoyant against the JPY in the wake of the poor economic data out of Japan. The real news though is that the EUR/JPY has made new highs. The Euro performance will complicate the job of the ECB. A too aggressive policy stance will likely push the Euro still higher, with negative economic consequences as Europe's international trade position suffers.

Data released in Europe has also been mildly disappointing. Unemployment in Germany remains high, Confidence in Europe is high, but not frothy and everyone is waiting for the negative fall out from higher interest rates, higher OIL and the appreciation of the Euro in 2006. Thus far the economic slowdown in the Anglo economies has not yet had a significant impact on growth. But nobody is talking yet of Europe as the global engine for growth. At best it looks like the Euro Zone economy could emerge over the remainder of 2006 as the best of a bad bunch. Which is still bullish for the Euro.

Trichet talks today. The market will be looking for signs of an October rate hike. There is a chance that given the more sombre economic climate globally that Trichet may give more dovish guidance than the market is looking for. The EUR/USD will need hawkish guidance to reach 1.2900 today, though there is a chance we see that target this week, provided U.S. data continues to show weakness. Our target remains set at 1.3000 for the EUR/USD as Summer trading comes to an end. The EUR bull trend is not over yet.

Data due to be released in the States today is unlikely to be market moving, everyone is waiting for NFP tomorrow. Any sign of economic weakness will see the USD come under further selling pressure, particularly against the EURO.

Global stock markets have been enjoying a relief rally as it becomes clear that interest rate rises may be less dramatic than previously forecast. For now the market is happy with the interest rate story and is ignoring the underlying economic fundamentals, which are worrying. It's too early to talk about a Global Economic Recession, but it is clear that global growth will struggle in the months ahead. Stock market bulls should be cautious.

OIL 70.49
GOLD 630.50

Despite the relative weakness of the economic data, the outlook for slower global growth and the associated softening in commodity prices, the OIL and GOLD bears are nowhere to be seen. That is not expected to change. GOLD will continue to benefit from uncertainty, poor global political leadership and the fact that global Central Bankers (or really the FED) has chosen REFLATION as its referred policy option. Although it is unclear if this policy choice will work (it didn't do the Japanese much good) the policy choice in itself will be enough to undermine faith in the USD.

Wednesday, August 30, 2006

The FED goes with PAUSE

EUR/USD 1.2829 Hi 1.2856 Low 1.2815
USD/JPY 116.98 Hi 117.16 Low 116.59
AUD/USD 0.7639 Hi 0.7649 Low 0.7612
EUR/JPY 150.13 Hi 150.28 Low 149.56

FED minutes released yesterday confirmed the view that the FED is going with the PAUSE. With no rate hike expected on September 20 and a rate hike unlikely at the October 24/25 meeting, given the proximity to the November 7 elections, this means that the first window of opportunity, should the FED choose to hike, would be December 12. But if, as it seems, that the quickest, least painful way out of the DEBT TRAP in the States is to REFLATE, then no rate hike can be expected this year. What we really have here is the PAUSE before the FED and the markets start talking about an EASE.

The Stock Market liked the news. And for as long as there are no secondary effects on other markets, notably the currency market, mildly bullish trading can be expected to continue.

Data out in the States today is not expected to change the overall outlook. The cost of America's debt binge likely to start showing up in data across the board. Slower growth from here on in is pretty much a given. The FED PAUSE policy can only be expected to limit the damage. Given America's massive debt burden, until REFLATION actually starts to take hold, little economic relief can be expected.

Yesterday saw the release of Consumer Confidence in both Germany and the U.S., the contrast could not have been more marked. The U.S. Consumer is heading for the hills while in Germany the outlook remains positive. Tomorrow we get the ECB meeting and, more importantly, guidance from Trichet. While no rate hike is expected, given the general positive tone of the economy in Europe, Trichet is expected to suggest that more rate hikes in Europe are likely. Another 25 points before the end of the year is likely.

The Bernanke FEDERAL RESERVE has clearly broken with Greenspan's policy position, although the market has not fully factored in this change. With no hikes likely in the States, rate hikes still on the table in Europe, the massive U.S. Trade Deficit, the huge U.S. external deficit, and a slowing economy, in contrast with the healthy state of external accounts and the economy in the Euro Zone, a currency realignment is on the cards.

EUR/USD is headed to 1.3000 over September. Downside from here is limited to 1.2750, with initial support seen at 1.2800. The only thing preventing the USD/JPY from taking a similarly USD bearish course is the concern that the Japanese economy will suffer as the U.S. economy slows. It will. Indeed, recent stats released in Japan have been disappointing. This, together with the exodus of foreign funds from the Tokyo Stock Market, may slow the USD/JPY descent or even see further mild rallies. The outlook for the USD/JPY over the medium term, however, remains bearish. For now, while the market grapples with these contrasting factors, trading opportunities will be limited. Longer term players should still sell the USD/JPY on rallies.

Oil 70.19
Gold 624.50

OIL saw a short lived break to the downside. With REFLATION the FED's preferred policy option and the USD likely to remain under pressure (not to mention GEOPOLITICS) the likelihood of a sustained bear trend in OIL is limited. GOLD saw similar trading yesterday, a short-lived bear move and a recovery. The FED's position suggests that the move towards GOLD as a reserve can only accelerate. GOLD is not headed for a bear trend any time soon.

Tuesday, August 29, 2006

Reflate or Deflate: the FED's Options Look Ugly

EUR/USD 1.2810 Hi 1.2840 Low 1.2776
USD/JPY 116.74 Hi 117.27 Low 116.57
AUD/USD 0.7621 Hi 0.7634 Low 0.7583
EUR/JPY 149.51 Hi 150.08 Low 149.47

Right now the "idiot savant" that is the Financial Markets is concerned with only one question: is the FED done? Around this little question fortunes are being bet. The idea is that the FED controls everything: the performance of the USD, the Stock Market, the United States Economy and the fortunes of our political masters. It's a nice idea. And it's simple so we can all focus on the data with the aim of guessing the FED's next move. But things are just slightly more complicated than that.

What we know is this: Anglo-Saxon economies are drowning in debt. This debt, given the paucity of domestic savings in these economies, has been largely financed by inflows of foreign capital. The aftermath of the Asian Crisis (1997-1999) facilitated these inflows. The Asian Crisis started in currency markets. Massive devaluations following ill-advised comments by the IMF official, Michel Camdessus, saw contagion and caused financial dislocation and real economic distress in emerging economies in Asia. For our purposes, however, what happened to the economies in Asia is irrelevant. What is relevant is that subsequent to the Asian crisis there was the huge drive by Asian Emerging Economies to accumulate sufficient foreign currency reserves to avoid any future currency crisis. That is: Asian Central Banks bought massive amounts of foreign currency, mostly USDs. This allowed the United States to run up an enormous external deficit and finance a massive domestic debt binge without the USD suffering and without a corresponding rise in domestic interest rates. It also allowed U.S. Officials to become nonchalant about the USD and debt financing in general: rates were low, credit was easy. Both the Public and Private sectors in the States have accumulated massive levels of debt which have financed speculative bubbles in the Stock Market, the Housing Market and allowed the Consumer and the Federal Government under Bush to go on huge spending sprees: the Iraqi War being a case in point. There are not expected to be any positive returns from the Consumer Debt binge or the War Effort, these are not investment propositions. After the event all that is left is the debt.

There are two possible solutions: the U.S. can attempt to reflate it's way out of the problem This would allow today's debt to become irrelevant in tomorrow's money. Essentially reflation means that the guy who lent you the money loses. To reflate the FED would need to stand pat or even EASE. Inflation would be allowed to re-emerge. It would also mean allowing the USD to devalue, perhaps abruptly. This would likely see foreign capital inflows slow or stop. Refinancing existing debt would become more expensive and, with the FED standing pat, the yield curve would move from its current negative slope to steep positive slope. This appears to be the FED's chosen option. It is not without risks to domestic financial markets and the real economy. Just remember what happened to Asia, which was flavour of the month with investors, before massive currency devaluations occurred.

The alternative would involve holding the USD close to current exchange rates and fighting inflation with steady or higher domestic interest rates. The yield curve would continue remain negative. In this way debt would financed via decreased levels of domestic consumption and/or a sharp reduction in the FEDERAL Government deficit. Retiring debt would require even greater economic retrenchment. Either way there would be a recession. And it could be severe. The result of this policy option would be: DEFLATION and an economic recovery which would be very much delayed. Think Japan in the 1990s and you get the general idea.

Right now there is no happy policy route for the FED. Bernanke the mild, however, seems inclined to REFLATE and be damned.

Financial Market Outlook

The USD has failed to rally, despite the reasonably positive performance of the U.S. Stock Market yesterday. While the market will continue to focus on the numbers, unless a very compelling NEW REASON to buy the USD emerges in the short term, the medium term risk for the USD remains to the downside. Prudence suggests: sell on rallies.

Oil 70.80
Gold 626.00

For now all quiet (well it's all relative) in the Middle East has seen the price of OIL retrace slightly.

Weak economic data out of the States, which remains the world's largest OIL importer, can be expected to see prices contained on the upside. Simmering GEOPOLITICAL tensions, however, suggest that the downside is also limited. For now we have range trading. The market needs new information.

Monday, August 28, 2006

Data and Geopolitics: USD Bearishness to Hit the Majors

EUR/USD 1.2812 Hi1.2818 Low1.2754
USD/JPY 116.96 Hi117.36 Low116.93
AUD/USD 0.7587 Hi0.7596 Low0.7563
EUR/JPY 149.83 Hi149.96 Low149.57

Busy week, lots of data and GEOPOLITICS is back. Just as Jacques Chirac announced that France would provide troops for the U.N. Peace Keeping Unit in Lebanon the little guy in Iran, who dresses like his hobby is train spotting, is back in the news. And when that happens the news is not good. First, we get news that Iran has intensified its nuclear programme. Which may or may not be aimed at meeting Iran's energy requirement. Let's give him the benefit of the doubt. But with blood-thirsty, UN-ELECTABLE "Neo-Cons" in power in Washington and a U.N. deadline scheduled for the end of the month, the timing is not good. Second, we get reports that Iran successfully test fired long range rockets over the weekend. Kinda of hard to make a case that the timing is accidental. So we have two sets of armed cowboys and a show down. One set of cowboys definitely sees this as some kind of pre-Viagra end game and the other set has been cut off from the world for so long by Washington's embargoes that no-one really knows what is going on over there. (What were the embargoes in aid of again?) Oh yeah, that's right: payback for chucking out the front man for Anglo-American oil: the Shah. Right-wing war monger conspirators are always such bad losers. Either way you only need one set of cowboys with nuclear bombs who are hell bent on engineering Armageddon to have a real crack at it. And there is only one country which has ever actually used the A-Bomb in a combat situation. Deep breath everyone.

So that's GEOPOLITICS. And the rest of the world is happy to just sit back and watch it happen. Appeasement by any other name?

Economic data due for release this week is not expected to change the overall economic outlook. The U.S. economy is in trouble. Consumer Confidence for August is out in the Sates tomorrow, together with minutes from the last FOMC meeting. Confidence is a leading indicator and the unsettled economic and political environment is expected to hit Consumer Confidence in the months ahead. Confidence is expected to fall from 106.5 to 102.5. The FED PAUSE on August 8 may see Confidence hold up better than anticipated but the overall economic picture in the States remains poor and Confidence should reflect that going forward. Forecasts for Non Farm Payrolls due Friday have been scaled back after the number has disappointed in recent months. Forecasts are centred on an increase of 125,000 jobs in August. There is no reason to believe that the number will not continue to disappoint.

Financial Market Outlook

But back to the markets. The Tokyo Stock Market took a hit today and is now down 2.17% since the beginning of the year. While some commentators are bleating on about the Japanese economic recovery being fuelled by a recovery in domestic demand that doesn't change the fact that Japan is essentially an export-orientated economy. The loss of the American export market due to failing U.S. demand for everything except military equipment will hit the nascent Japanese economic recovery hard. Markets are starting to react. Japan was one of the biggest market stories of 2005 and a great deal of the bull market run in Japanese stocks was fuelled by offshore buyers. Watch that unwind as reality sets in.

As the economic consequences of the policy mistakes made in the U.S. start to hit in the real world, Stock Markets remain at risk.

The USD bulls have had their run. Ugly GEOPOLITICS and bad economic data are going to make it extra-hard for the USD bulls to plead their case. Bernanke the mild is famous for his concern with deflation and the 1930s. There is just no possibility that the interest rate differential story will shore up support for the USD. And we still have the massive U.S. external funding requirement to contend with. So that pretty much leaves the Plunge Protection Team and the Central Banks of gullible Emerging Economies on the side of the USD. The post ASIAN CRISIS USD buying of Emerging Market Central Banks has, however, pretty much run its course and the new world order, where the United States plays ROGUE NATION, is likely to diminish appetite for USDs going forward.

The initial target for the EUR/USD is 1.2850 with 1.2900 likely on a break. The woes afflicting the U.S. economy are considerably worse than those afflicting Japan. Upside for USD/JPY from here is limited. Selling rallies is recommended. The underlying theme remains the same: the USD is at risk as massive over spending by the U.S. Government spills over into a massive external financing requirement.

The Australian Dollar continues to under perform. Concern about the health of the Global Economic Environment, Australia's massive external deficit, huge accumulated Foreign Debt and vulnerability to external economic shocks is likely to weigh on the currency. The AUD can be sold both against the USD and on the crosses. 0.7600 should hold the upside for the AUD against the USD but the EUR/AUD offers the best trading opportunity. Buy below 1.6800. Our target remains set at 1.7000

Oil 71.15
Gold 630.80

Concern about the health of the U.S. economy and the USD are expected to support both OIL and GOLD. Add GEOPOLITICS and the outlook for both remains bullish. GEOPOLITICS is the key to the support for OIL. The GOLD story remains the search for an alternative to the USD as the global reserve currency of choice. And that story is likely to run and run.

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