Friday, September 22, 2006

Non-Events and Nixon Moments

EUR/USD 1.2829 Hi 1.2833 Low 1.2776
USD/JPY 116.30 Hi 116.63 Low 116.19
AUD/USD 0.7554 Hi 0.7580 Low 0.7550
EUR/JPY 149.20 Hi 149.36 Low 148.60

The Bush Administration is having another Nixon moment. I guess Cheney and his buddies are still mourning their glory days with Tricky Dicky. And surprisingly, there is one thing that Nixon did achieve, his one legacy in an Administration marked by war-mongering and incompetence (sound familiar?): Nixon opened up relations between the U.S. and China. Shortly thereafter Deng Xiao-Ping announced that "To get rich is glorious" and subsequently China announced its Open Door Policy. Not that it is Paulson's trip to China which we are focusing on here. No, what could be interesting is the possibility that the Bush Administration decides NOT to bomb Iran but to go to the negotiating table and hammer out a deal.

Should President Bush actually manage to make something positive out of the mess he and his predecessors have made in the Middle East this would go some way to establishing his legacy. Not that New Orleans or the Iraq disaster would be forgotten, after all Nixon's reputation never really recovered, but a deal with Iran would certainly be better than another U.S. bombing campaign in the Middle East. Bush's softly, softly stance on Iran which emerged this week may just mean something. Provided of course someone can persuade that little politician from Iran to shut-up and move off centre stage. He may think he's a dab hand at negotiations and public relations but he seriously risks overplaying his hand. Bring back the Ayatollahs. If nothing else, they have a better dress sense.

Well the FED met this week just to catch up, chew the fat and do nothing. Just like everyone expected. Another non-event is planned for late October. Initially the market was happy. The confirmation that the FED is in PAUSE MODE helped the Stock Market bulls and U.S. markets made new highs. Records are tumbling all over the place. But the records to watch are those being broken on the U.S.'s ever rocketing current account deficit, the U.S.'s record level of Foreign Debt and the fact that the U.S. Treasury is relying on foreign investors to pick up circa 50% of the paper on offer at every new funding round, and there are plenty of those. Though the Stock Market bulls are a teensy bit concerned that the FED is in PAUSE MODE because the U.S. economy is gonna make a hard landing pretty soon. Data out this week in the States hasn't exactly been all joy and light. And there are worry warts out there starting to talk about just how hard the recession is going to be.

But not to worry Henry Paulson is on the case, encouraging the Chinese to buy less USDs so as to make the U.S. more internationally competitive. Everything will be fine. EVENTUALLY. Right now though the THEME on FX Markets, if you can call it that, is range trading. Ranges which have been in place pretty much since before the Summer are still holding. And so the market is complacent. The FAVOURITE TREND is the CARRY TRADE: you make points, you trade the ranges. Until of course those ranges break and all hell breaks loose. For now everyone is happy. So what if the FED has moved from HIKE MODE to PAUSE MODE, so what if the U.S. Current Account Deficit is 6.6% of annual GDP, so what if China and Japan are holding record levels of FX Reserves and are looking to diversify away from the USD, so what if the USD share of those reserves is falling, so what if Paulson is talking up the Chinese Yuan (and the currencies of all those naughty countries who continue to run large current account surpluses), the Carry Trade has been a winner and you don't stop backing a winner until you HAVE to.

Meanwhile, with the CARRY TRADE crowd looking the other way, the USD is slipping. The ECB is lining up to fight off the Carry Trade on the EUR/JPY. The recent EUR/JPY historical high is going to be just that. Though we may have to break decisively below 148.50 before we see a rush for the exits. And even then, those nostalgic for those lazy, point-earning Summer trades will keep on buying dips. This is a bad idea, but having to refocus and reassess is hard work. With the ECB holding down the fort on EUR/JPY and the USD seeing selling pressure, the real downside action will be on USD/JPY. USD/JPY is unlikely to see 117.00 again in the next little while, and anything above 116.50 should be sold. That doesn't mean that the EUR/USD uptrend is over, it just means that each new USD down move will start in the USD/JPY and then move to the EUR/USD. Though, ultimately this is not about crosses. This is about the DOLLAR and the USD downtrend is not over, not even close. Anything even near 1.2700 on the EUR/USD should be bought. The near term target is still 1.3000.

Other carry trade favourites: the AUD and the NZD look vulnerable. New Zealand just released spectacularly BAD current account numbers. The New Zealand current account deficit just reached 9.7% of annual GDP, which is Banana Republic territory. With those kind of numbers you need sky-high domestic interest rates just to keep the currency afloat. Think Iceland. Australia's numbers are slightly better, but still poor. Selling AUD and NZD versus the JPY is recommended. AUD/JPY is not expected to hold a break above 88.00 and 77.00 should cap the NZD/JPY.

OIL 61.98
GOLD 593.60

GOLD will benefit from the USD down move, increased global uncertainties (Thailand, Hungary, Iran, Afghanistan and so on and so forth), and the search for a safe haven. The GOLD rally continues.

Tuesday, September 19, 2006

That's It, It's Over. Now we go Back to Basics

EUR/USD 1.2660 Hi 1.2727 Low 1.2651
USD/JPY 117.54 Hi 118.14 Low 117.48
AUD/USD 0.7532 Hi 0.7566 Low 0.7530
EUR/JPY 148.81 Hi 150.29 Low 148.69

The USD has done all it can on the back of the G-7 failure to call for YEN strength. And it's been a fairly pathetic showing. Indeed, the USD bulls - who were so excited that there was not a concerted G-7 call for the USD/YEN to depreciate (a lot) - never stopped to ask themselves why Henry Paulson and his G-7 buddies thought best to avoid that particular topic and the associated risks. They didn't have to wait long for the answer. Next day: bang! The U.S. Current Account Deficit was back in the news. And the news was considerably worse than the pretty awful USD 218 billion headline DEFICIT which the U.S.A. recorded in the second quarter of 2006.

The details make ugly reading. The U.S.A. recorded a USD 4 billion net INCOME DEFICIT for the quarter. Which underlines the U.S.A.'s position as a debtor nation. There was a revision from a USD 1.9 billion Income Surplus in Q1 to a USD 2.5 billion Net Income DEFICIT. Which means that someone overestimated the U.S. Income Account by some USD 4.4 billion in Q1. What's more foreigners (mostly FOREIGN CENTRAL BANKS) now own nearly half of the USD 4.3 trillion Treasury market. The U.S. really NEEDS these foreigners to hold onto their U.S. Treasuries. It also needs them to continue to buy more. That's why Henry Paulson can't go tripping around the world to suggest that it's time the USD/JPY took a hit (sorry that the YEN revalues) because it would put at risk the whole U.S. Government Funding Programme. And with a war on in Iraq, Tax Cuts to Fund, and another war planned for Iran (and this time the U.S. really IS going in alone), not to mention the War in Afghanistan and the upcoming elections in November (which will require a bit of pork), there isn't room or time for a massive reduction in the Government's Funding Requirement.

No the really BAD NEWS was that in July the U.S.A. failed to attract the necessary capital to FUND its yawning external deficit. Net Capital Inflows for July came in at a measly USD 32.9 billion, which was less than half what was forecast and obviously a whole let less than the U.S.A. requires to keep the USD stable. This is how it works: either the U.S. sucks in enough money to meet its external funding requirement (circa USD 70 billion a MONTH) or the USD depreciates. A failure of confidence in the USD would not do a whole lot to encourage foreign investors to rock up for the next U.S. Treasuries Funding party, so Paulson stepped very carefully at the G-7. And his carefulness, more than anything else, should wake up market participants to just HOW PRECARIOUS the situation is. And how close we are to a massive USD depreciation.

For now the CARRY TRADE CROWD really is carrying the USD. But speculators get hurt. These are not real capital inflows and you don't need to meditate long on what happened in Hedge Fund Land this week to understand how badly this all could end. And when one fund goes criteria for everyone else gets tightened. Limits get scrutinised. Risks get reined in. And that is happening NOW.

PPI numbers released in the States today (which were lower than expected) don't really add anything to the general scenario. Except that they do confirm that Ben Bernanke and his DOVISH team at the FED are unlikely to hike tomorrow. Great. So higher short term interest rates will not be there as an added attraction to stock up on USDs. Same goes for the ugly news out of the U.S. Housing Sector (surprise, surprise).

GOLD 588.20
OIL 63.69

Gold (the anti-DOLLAR) seems to be doing just fine, even if inflation numbers are low right now and even if world growth is expected to run into trouble soon, meaning of course that the short term inflationary risk is not HUGE. The steady performance of GOLD is not about its role as a hedge against inflation, which it is. GOLD's big advantage is that it is NOT the USD. And that makes it a very compelling investment right now. Which is why this rally has legs.

Weaker world growth will not be good news for OIL, however, there does seem to be some lingering concern about the determination of the U.S. Administration to start a new conflict in the Middle East. And that would light a fire under the price of OIL. So the market remains caught. For OIL to see a serious decline the world needs to know that the U.S. Administration IS NOT planning another Middle East adventure. That is not yet clear.

Monday, September 18, 2006

Adrift in a Leaderless World

EUR/USD 1.2667 Hi 1.2687 Low 1.2628
USD/JPY 117.83 Hi 118.27 Low 117.22
AUD/USD 0.7520 Hi 0.7540 Low 0.7510
EUR/JPY 149.28 Hi 149.70 Low 148.21

George Bush is trying to make a strong case for upholding the U.S. right to torture prisoners, withhold evidence and generally take the world back to circa 500 AD. And if you don't like it you're irresponsible, unpatriotic and you'd better watch your back. So we have at least one guy on the world stage who knows exactly where he wants to take the world: back to the Middle Ages. Which for some people, maybe, was a pretty good place to be. Sackcloth will be the next big thing. The concentration of power and money in the hands of the few, the re-emergence of religious dogma as a guiding political force and political leaders who have an absolute certainty that their vision is guided by GOD. You have to hand it to Bush at least he is completely consistent.

Otherwise leadership is thin on the ground. The G-7 shindig which took place in Singapore this weekend provided little guidance for financial markets. There were no harsh words and no clear statements. Noticeably absent was the call for stronger Asian currencies, although there was some fudging along the lines that "nations with LARGE CURRENT ACCOUNT SURPLUSES, notably China, need to allow greater exchange rate FLEXIBILITY". Which means they need to allow their currencies to appreciate. A LOT. There was no mention of nations with LARGE CURRENT ACCOUNT DEFICITS. Though the corollary to the G-7 statement would be that nations with large current account deficits need to allow similar flexibility. Which would mean devaluation. But no-one mentioned that particular elephant in the lounge room. It's a topic which is, let's say, somewhat delicate. Paulson obviously knows the risks and preferred to let the matter slide. Although it would be interesting to know what is Paulson's definition of "vigorously doing its part" with regard to the Federal Government's Deficit.

With the U.S. status as a Super Power much diminished and the huge U.S. external funding requirement there for all to see, there was not much leeway for forcing through a new Plaza Accord. For now Japan and China get to decide their own exchange rate policy. If Asia wishes to continue its policy of accumulating an embarrassing quantity of FX reserves, that is their choice. Right now the U.S. is not in a position to turn the heat on Asian Central Banks and force them to cut off U.S. capital inflows. And so the party continues. For as long as the USD remains relatively stable, there is no major risk to global financial markets.

This week the FED meets. No change is expected in monetary policy. The ECB meets a little later and ECB spokesmen have been falling all over each other recently to impress on the public the fact that MORE RATE HIKES are coming. And coming. And coming. All the way through 2007. So far FX Markets have ignored both. The EUR/USD is still in the range it's been stuck in since early June. The lack of follow through on the upside and the ECB's attempt to cap the EURO against the JPY is making headway difficult. The failure of the G-7 to call clearly for an appreciation of the YEN and the Chinese Yuan has encouraged the USD/JPY bulls and the carry trade is back on. Fundamentals aren't supportive but, for now speculators are in control of the market.

OIL 63.65
GOLD 587.10

The big question on commodity markets is: have all the speculators (who were long commodities) been stopped out yet ?? The answer is unclear. Further falls in the price of OIL will require economic weakness to be confirmed in the United States. And GEOPOLITICS will need to stay off the front page. The Europeans are forging ahead with talks with IRAN, which is good news. Although Bush and his war mongers are not happy. So it might not be time to get too happy clappy about developments in the Middle East.

GOLD remains the anti-Dollar. While speculative selling pressure may see a further test of the downside the longer term outlook for the precious metal remains positive.

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