Thursday, October 19, 2006

Monetary Policy Fixation

EUR/USD 1.2556 Hi 1.2561 Low 1.2528
USD/JPY 118.57 Hi 119.03 Low 118.56
AUD/USD 0.7569 Hi 0.7575 Low 0.7540
EUR/JPY 148.90 Hi 149.24 Low 148.88

There are a couple of things which we know: the FED is not going to hike rates at its next meeting and the ECB is hell-bent on hiking another 25 points by December. What's more there doesn't appear to be much chance that the FED will hike or do anything at all THIS YEAR. Bernanke is in "wait and see" mode. There is an off-chance that the FED might ease by the end of 2006, but it's a very SMALL possibility and would require the U.S. economy to run off a cliff very soon. Economies don't do that. Growth or economic disaster are played out in slow motion.

Meanwhile the ECB is still trying to out-Bundesbank the Bundesbank so "extreme vigilance" might not be on the agenda right now, but it's lurking. Maybe that's what Rumsfeld meant when he talked about "Old Europe". Out here they have a hard time letting go of past glories and tired ideas. So in the minds of some, notably Trichet, the Bundesbank was a raging success. I think he admired their dress sense because it CAN'T BE the state in which they left the German economy which gets his heart a-flutter. But then Trichet never really had to deal in person with the consequences of recession. He has always had a nice safe, public service job with all the trimmings. What they need in Europe is a little of Clinton's "Can we move on?". But no, in Europe we can't and won't, and if you're not careful we might start waving around lace hankies.

Despite what is known about interest rate policy in the EuroZone and the U.S.A., and despite the rumblings out of Japan about more rate hikes coming, the market INSISTS on pouring over every little bit of data. And what they are trying to divine is the nuances in inflation and growth which just might change the monetary policy outlook. This is a pointless exercise. But it does mean that with every little bit of information the market acts like an idiot savant with bi-polar syndrome and no medication. While ranges hold and volatility is relatively contained the FX market becomes a proxy for interest rates. Interest rates differentials are driving FX Markets, not flows, but short-term speculators.

While everyone is looking at the consequences of CARRY trade, DIVERSIFICATION marches on, pretty much unheeded by the market. A couple of days ago the Russians announced yet more diversification of their Foreign Exchange Reserves. This means they want to hold LESS USDs. Now, in addition to Euros and Sterling, they want to hold the YEN from a YEN base of what is believed to be zero circa. Official figures are hard to come by, but the estimates out there suggest that the Russian currently divide up their Foreign Exchange Reserves as follows: 45% USD, 45% EURO and 10% Sterling. Russia's Reserves are estimated to be around USD 268 billion, with USD 181 billion held in Foreign Currencies. This makes Russia the Central Bank with the largest Reserves in the world, after Japan and China.

Russia's Reserves have risen enormously over the past year and there has been a marked shift out of USD holdings. According to some sources USDs made up circa 70% of FX reserves a year or so ago. The longer term trend towards diversification continues. And this is not good news for the USD bulls. And that is the longer term trend, regardless of what the bi-polar, short-term market would have you believe.

In the short term, however, data released yesterday suggested that the U.S. didn't have any trouble attracting capital inflows. After seeing capital inflows fall to just USD 32.9 billion in July, Foreign Capital inflows to the States surged to USD 116.8 billion in August. This was way more than the USD 56 billion the market expected and slightly more than the U.S. requires PER MONTH to meet its funding requirement. Most of the money coming from abroad is heading towards the U.S. Treasury market. Indeed, foreign investors now hold around 44% of the Total U.S. Government Debt on issue. Now that's an Achilles Heel if ever there was one. And whereas once the Foreign Holders of U.S. Treasuries were compliant people like the Japanese, now we have Russia and China. Neither have quite the same attitude to the Americans.

The USD is currently in the process of putting in a top against the JPY and the EURO. The November 7 election might muddy the waters a little, but that is what is happening. Anything above USD/JPY 119.15 is a sell. Anything below EUR 1.2500 is a buy. And the top for the EUR/JPY has been made.

OIL 57.90
GOLD 592.20

GOLD is trapped in a range. While the Carry Trade supports the USD, further significant upside is unlikely. The longer term prospects for GOLD depend entirely on the shift away from holding the USD as a global reserve currency. So, according to your point of view, the bullish case for GOLD is a slam dunk.

Tuesday, October 17, 2006

Surreal Market Chatter

EUR/USD 1.2531 Hi 1.2548 Low 1.2522
USD/JPY 118.92 Hi 119.16 Low 118.87
AUD/USD 0.7542 Hi 0.7550 Low 0.7527
EUR/JPY 149.05 Hi 149.37 Low 148.98

Retail Sales released Friday in the States helped trigger a few USD buy stops, but follow through has been limited, which isn't surprising. The big idea is that if the U.S. Consumer is still breathing then the FED will not ease rates any soon. But it's not a story which stands up to much scrutiny. Although Retail Sales fell 0.4% with enough digging into the data the market discovered that once you factor OUT gasoline then Retail Sales actually ROSE 0.6% over the month. Hurrah!! So the U.S. Consumer hasn't given up the ghost. Which means that rates are on hold, there is no ease in sight, and since we aren't trading currencies here but interest rate differentials, then the USD is still a buy. Well go with that story if you want. Judging by the massive amount of accumulated YEN shorts out there EVERYONE does believe it. What we have here is another market clear out waiting for a trigger. And you never have to wait long for a trigger when the market is set up properly.

Meanwhile there is concern that low savings, excess consumption and a massive external funding requirement might just not add up to a Strong Dollar Story, no matter what Henry Paulson would have you believe. And a U.S. Consumer still intent on going for broke, and I really do mean going for broke, might not do all that much for the U.S. Trade Deficit and that U.S. dependency on Foreign Capital Inflows, which at last count added up to something more than USD 3 billion a day. And that's NEW MONEY every day. So we need two things to happen here: a) Foreign Investors can NEVER cash in their USD denominated investments and b) we need to see foreigners rock up with a further USD 3 billion and change every single day. Oh, unless the U.S.A. actually decides to start saving, stop consuming and cut back its debt obligations. That's a long hard road and it requires effective economic management. It also requires to be sold to the electorate, which is the tricky part. It's so much easier to tell people that everything is just going to continue getting better, than to tell them that radical economic retrenchment needs to take place. So this U.S. Administration, and every past Administration in recent memory, tells the happy story at home and then tours the world with the good news so that Foreign Investors keep rolling in with the dough.

Today we will see just how many foreign investors ponied up for a few more little green bits of paper. The U.S. Treasury will release Net Treasury Purchases. Last time round these numbers were grim, but the old USD bulls out there aren't letting that worry them. Forecasters are positive. The story is that while U.S. Treasuries might not have attracted new money U.S. Stocks certainly did. Which is a strange thing to believe when the entire world is having a Stock Market bull run right now and why add currency risk to your investment risks by buying U.S. Stocks when you can buy stocks in your home market? If the world is making investment decisions based EXCLUSIVELY on interest rate differentials then you can, just maybe, make a case for the USD but you sure can't if the focus has shifted to Stocks. But then the USD bulls aren't logical, just desperate.

USD/JPY is likely to lead the USD bear show. Ongoing EUR/JPY selling by Central Banks is likely to slow the EUR/USD uptrend. But it is an uptrend and it is likely to accelerate. The USD is an accident waiting to happen, or maybe it is happening now. Friday should be seen as just the last little spurt, the last hurrah. And now we get the real action. The impact on OTHER financial markets is sure going to be interesting.

OIL 60.13
GOLD 600.00

GOLD is on the rise again, although there are weird stories out there about Russians selling GOLD to buy YEN, which makes sense since the Russians only just announced their intentions to DOUBLE the proportion of their Foreign Exchange Reserves held in GOLD and the Yen is obviously this high yielding currency, not. Market chatter is always interesting if nothing else for its sense of surreal. Anyhow, although there was a certain buoyancy to the tone of the USD in the past couple of weeks, it doesn't look like there is anything like a trend move into USD and away from GOLD. And why would there be? There is an administration in the White House which appears to be totally divorced from reality, a U.S. economy which just may have run out of brownie points, wars are still raging in fairly strategic places in the world and the tensions between the major political powers look like this new round of hostility could make the COLD WAR look like a walk in the park. When you think Russia, China, U.S.A. do you get this warm cuddly feeling? Neither do I.

Commodities in general seem to have reached the bottom of the recent clean out. Hedge Funds may have taken a hair cut, but then that's what happens when you have 9,000 hedge funds, lots of leverage and ONE idea. Ongoing economic growth in Europe and Asia is likely to keep the ball rolling here. We may see a benign inflationary story emerge in the next few months as the fall in commodity prices feeds through to the end user, but overall the concern is that INFLATION is not dead. And it's not. Once the Hedge Fund distorted smoke blows away the impact of past monetary policy mistakes is likely to become clear. Greenspan's monetary policy response to the non-existent Y2K threat (what was that about anyway? Something about all the computers in the planet shutting down at midnight..... surreal is always with us and people keep buying it. Freud would go wild.) is likely to go down in history as one of the REAL GREAT monetary policy mis-steps.

There has been muttering in the market about the manipulation of the OIL price, in cahoots with Saudi Arabia, in the run up to the November 7 election. The idea is that Karl Rove and his team want the U.S. voter to FEEL GOOD and vote back the team which is responsible for the recent record Stock Market performance and the low (well it's all relative and we know that Americans have a short attention span) OIL price. I'm not sure how much credence to give to this story, particularly given the U.S.'s standing in the Middle East right now. But it does seem that OIL potentates stick together. One way or the other it doesn't seem that the bear case for OIL is particularly strong or likely to be sustained past November 7. OIL, with commodities, can be expected to move higher.

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