Tuesday, November 07, 2006

Debt Financing in a World of Rising Rates

EUR/USD 1.2810 Hi 1.2820 Low 1.2720
USD/JPY 117.33 Hi 118.35 Low 117.25
AUD/USD 0.7755 Hi 0.7761 Low 0.7701
EUR/JPY 150.35 Hi 150.60 Low 150.16

Interest rates again: some noises out of the BoJ concentrated minds on financial markets. The BoJ is gearing up to raise borrowing costs. The ECB is gearing up to raise borrowing costs, with more increases predicted for 2007. The BoE is expected to raise interest rates this week and that move won't necessarily be the end of the cycle because Credit Growth in the U.K. is still out of control, Housing Prices are rising and the BoE is not happy. The RBA is expected to bump up interest rates some time soon, despite the drought, expectations that the Commodity Prices may have peaked and the very high level of Household Debt to Disposable Income in Australia.

Meanwhile the FED is still in PAUSE mode and despite some vaguely positive NFP numbers Friday, well the Unemployment Number fell which is something, the overall picture of economic health in the United States is not generally as positive as the Dow Jones, President Bush and his lackey, Henry Paulson, would have you believe. Indeed, a number of commentators have suggested that GDP numbers for the Third Quarter overstated growth by quite a bit.

Some suspect shenanigans involving Motor Vehicle Output, which added 0.72% to overall GDP growth in the quarter, in spite of the fact that New Car Sales actually fell quite sharply. Depending on which survey you look at Motor Vehicle Sales either fell by 11% or by 7.6% over the quarter. So Output was UP but quite a lot of Inventory must have been produced and little else. Nobody was ACTUALLY buying those New Cars. In addition, there have been rumours and murmurs about the GDP Price Deflator, which fell from 3.3% in Q1 and Q2 to just 1.8% in Q3. Without that fall GDP growth would have been FLAT for the quarter. Hmm. Not everyone believes that the fall in the GDP Price Deflator can be justified.

Add these two factors together and GDP numbers are more likely to be revised DOWN than UP. So growth for the quarter, in the final analysis, is likely to be lower than the already poor 1.6% annual rise recorded. While you can massage the data for a while (electoral necessity and all that) eventually the TRUTH will out.

What we do know is this: the U.S. economy is an economy which depends to a very large extent on the easy availability of credit. Without easy money both the Federal Government and the average U.S. Consumer will have to cut back. Debt financed economies will suffer as the cost of debt financing goes up. That's a pretty simple, straight-line correlation. And so to expect U.S. growth to continue unimpeded as the cost of debt rises (note what world Central Banks are doing RIGHT NOW) is probably not the right view.

And that's without even considering the fall out from the implosion in Residential Real Estate which is currently taking place in the States.

USD short covering post NFP seems to have run its course. We are back to fundamentals and the USD fundamentals are poor. China, which is holding ever more foreign currency in its reserves, recently made the point that the problem as such is not that the Remnimbi is undervalued. No. The problem, according to the Chinese, is that the USD is overvalued against most major currencies. Now you may argue with the vested interests of the Chinese but its hard to argue with their conclusion.

This point of view does seem to becoming, well, pretty well accepted. So, it's back to selling the USD on any sign of strength and wondering when the whole thing is going to crack.

OIL 59.95
GOLD 629.70

OIL is holding just under USD 60,00. Which may or may not make Mr Joe Average relaxed and comfortable. What we do know is this: unless world growth comes to crashing halt there is not much scope for further falls. So whatever deal Bush may or may not have made with his Saudi allies, whatever the state of the U.S. economic slow down, unless growth in Europe and Asia come to a dead halt the price of OIL is more likely to go UP than to fall.

And GOLD simply remains the ANTI-DOLLAR at a time when being ANTI-DOLLAR is very much flavour of the decade. Now whatever happened to the Gold Cartel? I guess there are only so many balls which you can keep in the air at any one time and, as every good trader knows, you just don't stand in front of moving train.

Monday, November 06, 2006

Economic Policy by Proxy

EUR/USD 1.2709 Hi 1.2725 Low 1.2689
USD/JPY 118.34 Hi 118.48 Low 117.79
AUD/USD 0.7696 Hi 0.7713 Low 0.7670
EUR/JPY 150.42 Hi 150.56 Low 149.85

There is an election in the U.S. tomorrow and we care because all those Republicans who voted to invade Iraq will be tossed out and replaced by Democrats who voted to invade Iraq. Saddam Hussein has been given the death sentence for War Crimes or Crimes against Humanity, or something of that ilk, and the world is now waiting to see what sentence will be passed on Bush, Cheney, Rumsfeld etc. for invading a sovereign nation without U.N. sanction and without provocation, laying waste to that nation and killing upwards of 600,000 Iraqis. And the U.S. isn’t even done yet. The people who invented carpet bombing know how to do destruction. So more death and destruction will happen.

The U.S. has spent an awful lot of money on weapons of mass destruction over the past 50 years and as Madeleine Albright wisely pointed out: “What’s the point of having this superb military you’re always talking about if we can’t use it?” Indeed.

So, given that the U.S. is sitting on this huge arsenal and is obviously willing to use it on a whim, no-one expects to see Bush on trial at The Hague any time soon. But conclusions have been drawn and lessons have been learnt. Over the weekend six more Arab Nations, some with Oil reserves some without, announced their interest in developing nuclear technology. Not that they don’t trust their old buddy Uncle Sam, but you never can tell. It's better to be just a little bit better armed than Saddam Hussein if you want to avoid a similar fate. The world might not be a safer place now that Saddam Hussein is no longer in charge but at least we all know where the danger lies.

Nothing will change tomorrow. The outstanding paranoia of the United States which has led to the biggest military build up in history is not going disappear with more Democrats in the Senate. U.S. economic policy is not going to be any better or more balanced. The current U.S. Administration isn’t even trying to manage the economy. So we are left with the same old game: guessing what the FED will do next, because there really isn’t any one else in charge.

The release Friday of U.S. Payroll numbers got the FED guessing game going again. And now the view is (hey this is new) the FED is in PAUSE mode. This is marginally better for the USD than the economy is falling of a cliff and the FED will need to EASE soon, but not as good as the economy is booming, inflation is picking up and the FED will have to HIKE soon. So for now we go with the FED is PAUSED and buy back some of your USD shorts.

Since the economy is now booming, well not collapsing anyway, we are also going with sell U.S. Treasuries as fast as you can and buy Stocks. The fact that one dismal little statistic can create such a radical reassessment of where the economy is heading is slightly depressing. However, with an election tomorrow the Bush Administration is cheering, a bit.

This week the Bank of England is expected to raise rates. This is another "economic policy by proxy" phenomenon happening here. The Government in Britain is good at setting up committees, creating league tables, introducing MBA-talk where it is completely useless but the economy is being driven by credit creation. And the problem seems to be that so much of that credit creation is directed into Consumption and Residential Real Estate. Now there are things that can be done about that at the Government level but that is not happening. So the easy answer is to raise rates. A couple of rate hikes and hopefully credit creation will collapse and if that happens to take a few Productive Industries down at the same time, well too bad. Nuanced, well-directed economic policy is definitely in the “Too-Hard Basket” so we go with One-Size-Fits-All Monetary Policy and a few more wild economic swings which tend, in the long run, to be very hard on Industry and economic well being. Today's politicians are, however, certainly not interested in or capable of dealing with the long run. It doesn't follow that Central Banks necessarily are.

While the FT may not be happy, the fact that the ECB is hamstrung, a little, because it has to make monetary policy fit all the divergent EURO Nations fills me only with joy. The less leeway we give to these people the better. Central Bankers of the world, on the whole, have a fairly dismal track record and there is no reason to believe that endless fiddling with interest rates is the way forward. So less is more when it comes to monetary policy and Governments will have to work harder to deal with economic conditions, distortions, bubbles, the misallocation of resources and what have you. Which is, after all, what they are paid for.

The GBP seems to have seen all the gains it is likely to on the back of the interest rate story. We may have to wait for the BoE to do the deed but EUR/GBP is starting to look like a buy. Anything below 0.6680 certainly is.

OIL 59.38
GOLD 628.50

OIL is currently three times the level Rupert Murdoch predicted it would be post the Iraqi invasion which he, and every single one of his newspapers, strongly supported. So, in addition to being wrong, Mr Murdoch has blood on his hands. OIL is, however, slightly below its recent peak. This is adding to some of the bullish stock market chatter out there.

What we have in reality though is a very nasty conflict in Iraq, a Bush Administration which neither understands the Middle East or indeed anywhere else and believes that force is the answer to EVERYTHING, an Iranian Administration which is not playing ball, unsettling noises from other OIL producers who are obviously concerned about U.S. Foreign Policy and a fairly nationalistic approach to Energy Policy in Russia. This is not the sort of environment in which there is much possibility that the price of OIL will fall through the floor any time soon. OIL shorts will have to be fast on their feet.

Meanwhile GOLD continues to rally. GEOPOLITICS may not be all over the front pages but Israel is keeping up its seige of Gaza and there are all sorts of nasty rumours about what is likely to happen in the region some time soon. Inflationary pressures are not dead, China is still buying commodities and making deals with primary producers everywhere and the U.S. Administration is doing its collective best to remind the world of Humphrey Bogart's role in the Caine Mutiny. In short the GEOPOLITICAL situation would require careful handling by skilled leaders and we don't have any on hand at the moment. So the outlook for GOLD still looks good.

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