Friday, January 26, 2007

The Great Unravelling

EUR/USD 1.2902 Hi 1.2947 Low 1.2889
USD/JPY 121.44 Hi 121.66 Low 121.20
AUD/USD 0.7727 Hi 0.7752 Low 0.7723
EUR/JPY 156.71 Hi 157.45 Low 156.59

Weak economic data released in the States yesterday did nothing to stop the slide in U.S. Treasuries. The U.S. Treasury market, largely unremarked by U.S. newswires, has been under considerable pressure lately and the poor outcome of this week's Treasury Auctions have done nothing to dispel the gloom in the market. Even with a modest rebound in the USD yesterday and signs that the economic "cooling" in the U.S. could turn into a hard landing, there was no bounce in Treasuries. It has been a very, very bad week for the U.S. Fixed Interest Market.

The best explanation for this bizarre turn of events from people in PUNDITLAND was that the weak data might be a sign that economic activity is bottoming out. Well yes it might, it might also be a sign that economic activity is weak and unlikely to improve significantly in the medium term, particularly with short term rates on hold and longer term rates RISING. Economic growth in the U.S. is after all almost entirely debt driven.

Markets are still working on the assumption that economic data determine direction. So if weak data doesn't produce a rally in Treasuries it must mean that the data wasn't all that weak. It's as if everyone was assuming that all economies are closed and isolated from international capital flows when, in fact, international capital flows together with speculative position taking (otherwise known as hot money) basically determine what happens on markets these days. And right now we don't have international investors queuing up to purchase more U.S. Treasuries.

Yields on 30 year bonds look set to break through 5% in the very short term. 10 year yields won't be far behind. Before long the U.S. Yield Curve will be flat and could very easily turn positive. And it all comes back to DIVERSIFICATION of assets by Foreign Central Banks. Which is another name for capital flight. No doubt someone out there in PUNDITLAND will start making the case that a Positive Yield Curve (that is a situation where short term rates are lower than long term rates) is a sign that the U.S. economic outlook is positive too. It would be a very weak case.

George W.'s State of the Union this week did nothing to restore faith in the direction of U.S. Foreign Policy and, let's face it, economic policy isn't even on George W.'s Agenda. Hell, even New Orleans isn't on his agenda so why would he worry about the economy? The policy focus of the current U.S. Administration is centred entirely on Foreign Policy and the results are there for all to see: one ruined country, 650.000 dead Iraqis, a lot of money spent and more conflict planned. The Senate might have voted against the SURGE but, as Cheney said this week: That won't stop us. In fact it is quite clear that NOTHING will stop these guys. Not economic ruin, not military failure, not the U.N. and not the U.S. electorate. Although it has been suggested that bankruptcy might be the least worst outcome. The alternative, of course, is Armageddon and a lot of people in the U.S. seem to be hoping for that outcome so that they can all go around saying: "I told you so". I'm not sure if this is something to do with Christian Fundamentalism or the idea that if the U.S. can't run the world then they may as well blow it up. That way no-one else will be able to run it either.

There is some kind of a theory going around at the moment that higher yields on U.S. Treasuries will help support the USD. It's a nice idea. The assumption behind it is that all the people who don't want to buy U.S. Treasuries at current levels will be queuing up to buy them as the yield moves higher. Only the reason that the yield on U.S. Treasuries is rising right now is because buyers are NOT enthusiastic. And what's more as the Treasury market falls any potential buyer, unless by some miracle he manages to get in when the market is at its nadir, will face a capital loss on his investment. So the idea that a falling Treasury market will lure back International Investors to U.S. Financial Markets is nothing more than a nice idea. You wouldn't want to throw any real money at it. And you certainly wouldn't want to start loading up on USDs on the back of trouble in Treasury Land.

Oh and by the way we may have just seen the peak in Stock Markets this week. As in THE PEAK. Now we get to see how leverage works in reverse. The Great Unravelling has begun.

OIL 54.41
GOLD 647.00

GOLD has enjoyed a good run, bolstered by increased volatility on financial markets and the increasingly unstable GEOPOLITICAL scenario. That might be the last of its bull run for the next little while as the bigger trend of collapsing Commodity Markets takes over. GOLD remains a good longer term bet but leverage and skullduggery must not be overlooked as market moving forces. After all it does appear that part of the PPT's brief is to ensure that no credible alternative to the USD as a Global Reserve Currency emerges. When you have an External Funding Requirement as large as the U.S. External Funding Requirement you need to hold on to your Reserve Currency status for as long as possible. So part of the PPT's brief is to ensure that confidence in GOLD and the EURO are systematically undermined. They haven't done all that well but they haven't slunk off the stage quite yet.

OIL briefly rallied after George W. committed the U.S. to doubling its reserves. That and cold weather have kept the price of OIL above the USD 50 level. For now we have range trading as the market tries to figure out just how bad the situation in the Middle East is likely to get in the short term and just how weak Global Demand really is.

Weak global economic activity and weak global international commodity prices could turn out to be the story of 2007. Not that the cheerleaders are giving up yet.

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