Friday, September 15, 2006

The Benign View

EUR/USD 1.2643 Hi 1.2737 Low 1.2631
USD/JPY 117.60 Hi 117.79 Low 117.34
AUD/USD 0.7515 Hi 0.7564 Low 0.7507
EUR/JPY 148.74 Hi 149.86 Low 148.67

Today's U.S. Inflation data came out right on the nose. Up just 0.2% for both Core and Headline Inflation in August. This brought the annual rate of Headline Inflation to 3.8% and Core Inflation to 2.8%. With FED FUNDS at 5.25% and a slow down under way in the States, there seems to be no need to hit the panic button. Analysts are already chattering about the fact that today's numbers don't include recent fall in the price of fuel. So it looks like luck is with Ben Bernanke. The FED is not expected to hike next week. November 7 elections suggest that a hike on October 24/25 is unlikely (too fraught with political difficulties). That leaves December 12 as the last possibility for a rate hike this year. Chances are there will be NO FURTHER RATE HIKE in the States this year. The FED will have time to assess the extent of the current economic slow down and its impact on inflation before they make their next move. The DOVISH Bernanke FED is sitting pretty.

Stock Markets are happy. While the FED PAUSE may have a lot to do with slowing economic conditions for now the only thing that counts is that rates aren't going anywhere in the short term. What's more the exodus from Commodities by speculative players isn't over. And as falling commodities prices feed into lower inflationary pressure, the case for a FED PAUSE will only get stronger. And that can be said without even considering the fall out from the Housing Market slow down on Consumer Spending.

This adds up to a fairly benign economic environment: slower growth, falling inflationary pressure and stable short term interest rates. That is certainly what the NEGATIVE YIELD CURVE is currently factoring in.

So far the USD hasn't seen any real selling pressure, despite the fact that the "rising interest rate" prop has been taken away. EUR/USD is seeing selling pressure and the USD/JPY remains mysteriously dead in the water. With the G-7 scheduled for the weekend it's the USD/JPY which should be watched. The EUR/JPY remains near record highs. This continues to cap EURO rallies as European Central Banks are in the trenches fighting off further gains. The U.S. and the Europeans are lined up. The G-7 is here and political pressure means that the end of the JPY carry trade is near. USD weakness will start with USD/JPY. But it won't stop there.

OIL 62.97
GOLD 582.50

GOLD and OIL continue to fall. This is not over yet. Weaker global growth, contained inflationary pressures, together with the unwinding of speculative positions suggest that SELL THE RALLY remains the way to go.

Thursday, September 14, 2006

Waiting for a Break Out

EUR/USD 1.2702 Hi 1.2737 Low 1.2675
USD/JPY 117.58 Hi 117.79 Low 117.35
AUD/USD 0.7549 Hi 0.7570 Low 0.7510
EUR/JPY 149.39 Hi 149.69 Low 149.03

The FED's job just keeps getting trickier. While Leading Indicators of Domestic Economic Activity are POINTING DOWN it doesn't look like slowing domestic activity ALONE will be enough to quash inflation, unless of course domestic demand falls off a cliff entirely. Which is always possible but probably NOT a result the FED would be happy with. And the Bush Administration can't really afford to have an economic disaster on its hands to match its Foreign Policy Disaster. While you can spin the War on Terror as a necessary evil it's kinda hard to convince people at home that higher unemployment and falling standards of living are good for them. And, despite reports of vote rigging, the Bush Administration can't really afford to enrage the ENTIRE electorate. Well they could try but before long they would have to face down some kind of insurrection, which wouldn't be good. So the stakes are high and the pressure is on.

Data released today pointed out where the trouble is: Imported Inflation (care of USD weakness - the USD has fallen 2.9% on a Trade Weighted basis this year) and high international commodity prices (care of the War in Iraq, the rise of Asian demand, excessively loose international monetary policy etc.) are at the heart of inflationary pressures in the USA. Import Prices rose 0.8% in August and were up 0.5% ex-OIL. While the price of Imported Consumer Goods was unchanged and the price of Good Imported from China actually fell 1% Y/Y (that pesky TRADE DEFICIT again) the prices of Imported Industrial Supplies rose 1.8% ex-OIL. This is pretty basic stuff: the inflationary risk for the U.S.A. is imported. Domestic inflationary pressure may well subside as domestic demand slows BUT imported inflation is likely to remain a concern particularly if the USD comes under pressure.

AND the U.S. Public hasn't exactly thrown in the towel on spending, despite astronomic debt levels and higher domestic interest rates. Retails Sales for August which were released today were not high (up 0.2%) but were still higher than most forecasts.

Details, details, details. Everyone knows that the U.S.A. will be pushing for a weaker USD (sorry stronger Asian currencies) at the upcoming G-7 and everyone knows that the gigantic U.S.A. external deficit is the greatest threat there is to international financial market stability and global economic growth right now. The FT amused itself recently by publishing a spurious little article by John Kay suggesting that Italy MAY leave the Euro. And wouldn't that be exciting? And what would happen then? Yeah right. The real Argentina risk right now is spelled: U.S.A. and everyone from the IMF to Henry Paulson KNOWS IT. The BIG QUESTION now for the world is: how does the world and its financial architecture manage to rein in the U.S. current account deficit without causing financial market meltdown? And there are no easy answers.

Of course, trying to undermine alternative global reserves (EURO, GOLD whatever) serves the purpose of supporting the USD's fast diminishing status as global reserve currency. The argument wears a little thin, however, when economic fundamentals don't support the case for the U.S.A. being THE leading global economic power. And right now U.S. economic fundamentals are as BAD as they have ever BEEN. The catastrophic leadership provided by the Bush Administration has accelerated the process but the U.S.'s position as a Super Power has been eroding for decades. All the spin in the world from Paulson et al doesn't change that.

USD bears are getting back into gear. The USD/JPY has seen a medium term top at 118.00 and more downside can be expected from here. The G-7 can be expected to give the USD/JPY downtrend a little kick along. 117.00 is the near term target, but further downside can be expected. The EUR/USD looks likely to test 1.2800 in the short term and 1.2700 should hold the downside from here.

OIL 64.24
GOLD 601.00

Every analyst in the world, especially those who were calling OIL at USD 100 by the end of the year, have suddenly noticed that OIL has broken down. And now, of course, there is talk of wholesale reversal in commodity markets. The Asians, I suppose, are just going to slink off into the background and stop buying commodities. The optimism is such that some commentators now see USD 40 as the medium to long term target for OIL. And THAT reversal, from calling USD 100 to calling USD 40, took about a month. So much for PEAK OIL and all the doomsday crowd. Right now OIL has fallen a bit over 12% from its peak and is up about 300% from the lows registered in 2002. So we probably shouldn't get too excited about the BEAR CASE for OIL quite yet. Unless, of course, you take the view that the Global Economy is going to hit a brick wall in the near term.

Wednesday, September 13, 2006

Beware Options Expiry, CPI and the G-7

EUR/USD 1.2682 Hi 1.2703 Low 1.2665
USD/JPY 117.64 Hi 118.04 Low 117.53
AUD/USD 0.7518 Hi 0.7527 Low 0.7482
EUR/JPY 149.24 Hi 149.78 Low 149.11

There are a lot of records being set out there. The U.S. announced another RECORD Trade Deficit yesterday. With oil climbing to a record in July and exports slipping, the U.S. deficit increased 5% to $68.04 billion from $64.82 billion in June. This surpassed the previous record of $66.6 billion set last October. For now the markets are happy with that, after all the U.S. Trade Deficit is not exactly a new trend. A lot of analysts focused on the the fact that OIL prices were high, so that must be the problem. U.S. exports weren't exactly booming, though. They fell 1.1% to $119.97 billion. I guess now that OIL is down a little the U.S. will start running a Trade Surplus soon. Just kidding. Still the bulls were in charge yesterday. The USD held onto recent strength and the U.S. Stocks and Treasuries rallied.

The Chinese and Japanese also reached milestones recently: RECORD levels of FX reserves. Interestingly though, China also just announced that existing FX Reserves are ENOUGH. Which means, I guess, that the Chinese will stop recycling their export earnings into USDs and U.S. Treasuries. Markets ignored these comments. It's early days. This trend hasn't really taken off. Odds on though that if the U.S. Trade Deficit starts to fall it's because our Asian friends are no longer prepared to fund it.

Still the USD has held onto its recent modest gains against both the JPY and the EUR. And the market is still bullish the USD, particularly against the JPY. USD bullishness is supported more by positive carry returns and speculators than by real capital flows or economic fundamentals. The G-7 is set to meet this weekend in Singapore and the mutterings are about the need to see a realignment in existing currency parities. The U.S. and the IMF are NOT pushing for a STRONGER DOLLAR here, guys. What the U.S. wants to see is a devaluation of the USD which can be passed off as an Asian REVALUATION so as not to scare current holders of USDs and U.S. Treasuries. The U.S. can't afford to risk foreign capital inflows quite yet. And the IMF this week has noted the risks of a disorderly USD devaluation. That is: if the USD crashes the consequences could be nasty. The ECB has also made this point. Traders should note that NO-ONE in charge out there is talking about a USD revaluation.

This could be a very interesting END of WEEK. We have Options Expiry, the U.S. CPI release AND the G-7 meeting gets underway in Singapore. Central Banks are still talking various degrees of HAWKISHNESS, although real follow through is most likely in Europe. The move to quash global liquidity is not over yet. Asia and Europe are not done and there are all sorts of question marks about U.S. Monetary Policy. One thing is certain: the days of excessively easy money are ending. Financial markets haven't yet dealt with the consequences of that sea change.

OIL 63.94
GOLD 592.30

Commodities remain under pressure. For now this looks like position squaring but some commentators, notably the Super-Bear Stephen Roach at Morgan Stanley, is calling the top in the commodities cycle. The Roach view in a nutshell: a global economic slowdown is underway. This slowdown started in the U.S. Housing Sector and will spread to the rest of the world, particularly export-driven Asia, as U.S. demand for Asian imports take a dive. Not a spectacularly new view, but the one that stands up the best on examination.

With the market still long commodities the risk is for further selling pressure to emerge. GEOPOLITICS are off the agenda. Europe seems to be making progress with Iran. The possibility of another conflict, which was widely predicted before year end, now looks unlikely. So we have fading GEOPOLITICAL risks, the mass exodus of speculators from commodities and slowing global growth. The risk is for further falls in the price of OIL. A test of USD 60 looks likely. There is one caveat: that there is no substantial devaluation of the USD.

GOLD looks set for a test of USD 580 In the short term. There has been talk of European Central Banks selling into the GOLD market over the past week and the rush out of commodities will continue to weigh on the market. However, given that Central Banks such as China will have to find an alternative home for their export earnings (which are unlikely to disappear in the short term) the longer term outlook for GOLD remains positive.

Monday, September 11, 2006

Nixon Redux

EUR/USD 1.2715 Hi 1.2743 Low 1.2648
USD/JPY 117.30 Hi 117.42 Low 116.61
AUD/USD 0.7531 Hi 0.7548 Low 0.7507
EUR/JPY 149.17 Hi 148.36 Low 147.75

Well it's September 11 and Bush and his cronies are making the most of it. Vice President Cheney is saying "if we had it to do over again, we'd do exactly the same thing." These guys are big on repeats. This is the Nixon Administration Redux. And while it may be a slightly surreal repeat of the 1970s they're doing their darndest. We have another OIL crisis, a war in IRAQ which may or may not turn out to be another VIETNAM, gloomy talk about a U.S. recession, STAGFLATION lies in wait, President Bush has made plans for another trip to the moon, there is talk of conspiracy which may or may not involve Government officials, there have been leaks and skullduggery. And that's just what we know so far.

Nixon ended up disgraced and impeached. And the unsavoury details surrounding Nixon Redux suggests that particular line of endeavour could prove even more interesting the second time round. So far Karl Rove has kept his job and Rumsfeld and Cheney are digging in. President Bush's Poll ratings may be in the dog house but there are ways and means of ensuring election results and they seem to be working. Years of practice at rigging elections, intimidating the opposition, subverting democracy and channeling funds to your business buddies in third world nations around the globe are NOW being put to good use in the United States of America. When you got that kind of KNOW-HOW on tap what do you expect??

Meanwhile Bush's best friend, Tony Blair, is making a whistle-stop tour of the Middle East. Not that the Lebanese are particularly keen on the visit. But Tony is a dab hand at facing down criticism, digging in and obfuscating while he flashes his famous smile. Maybe it will play well with the voters back home: war on terror, international statesman and all that guff. He hasn't got a hell of a lot else going for him right now so, if they can keep the protestors at bay, he may come home with a couple of nice snap shots and all the nasty stuff about him being complicit in the destruction of Lebanon can be forgotten.

Meanwhile the associates of the Cheese-Eating Surrender Monkeys seem to be making progress with Iran. It's not the kind of progress the United States and it's ally Britain are making in Iraq and Afghanistan, but then when you don't use bombs as your primary negotiating tool what can you expect?? Washington's Neo-Cons are unlikely to be pleased. The Neo-Cons thrive on war: an expensive war, a few restrictions on national freedom of speech, lots of money poured into your favourite industries and a HEY PRESTO suddenly you are sitting on a retirement fund which would normally be beyond the wildest dreams of your average Yale dropout. Tony Blair obviously hasn't been paying attention.

This week is CPI week in the U.S., the market is looking for CPI to rise 0.2% (both the headline rate and the core rate). A higher rate will see all the USD bulls come out of hiding as they factor in another rate hike before the end of the year. FED SPEAK at the moment, though, suggests otherwise. Should the CPI rate be worse than expected the FED will suggest that: a) previous rate hikes have yet to work their way through the system and b) that the current slow down in economic activity will bring inflation down in coming months. The FED can not and will not suggest that they are not CONCERNED with inflation, BECAUSE THEY CAN'T SAY THAT. What they will do if inflation comes out higher than expected is make soothing noises and continue TO PAUSE. USD bulls should be cautious.

The JPY took a hit this morning following the release of extremely poor Machinery Orders data for July. This volatility has encouraged some USD/JPY bulls but should not be confused with a new trend. The global slow down has U.S.A. stamped all over it. While currency markets try and work out the conflicting signals for the majors, one currency stands out as a sell: the AUD. The AUD will suffer as global growth slows and commodity prices take a hit. The Australian economy is already showing signs of weakness and Australia is running a fairly hefty trade deficit. 0.7600 is expected to hold the upside. The short term target for the AUD on the downside is 0.7450. EUR/AUD is within striking distance of 1.6900, with 1.7000 likely to be seen in the medium term.

OIL 65.28
GOLD 600.50

Signs of progress in Iran have helped the OIL bears press their case. For now the "Neo-Cons" are on the back foot. There are few chances of widening the present conflict in the Middle East or opening a new front in the War on Terror somewhere else in the world. So the WAR PREMIUM in OIL is tumbling and, with a global recession looming, the bullish outlook for commodities has taken a big hit. As speculators rush to unwind one of the favourite plays of the past 12 months further downside for OIL looks likely. The fall out on the commodities market is likely to continue for a while yet.

GOLD has also taken a hit on the back of the rush out of commodities. The U.S. has no interest in GOLD becoming a substitute for the USD as a global reserve currency and the Plunge Protection Team is likely to push this down move for all it's worth. USD 580 on GOLD seems possible from here. Longer term players, however, should be looking for an opportunity to buy. The USD's status as a reserve currency has been undermined by the Bush Administration's poor Economic Policy Management AND by its globally unfriendly you are either with us or against us Foreign Policy. It will be hard for the U.S. and the USD to recover quickly from such mastodontic policy errors. GOLD remains THE global reserve by default.

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