Thursday, May 31, 2007

Misreading the FED Minutes

EUR/USD 1.3466 Hi 1.3424 Low 1.3466
USD/JPY 121.58 Hi 121.46 Low 121.69
AUD/USD 0.8274 Hi 0.8277 Low 0.8218
EUR/JPY 163.71 Hi 163.77 Low 163.04

Funny how things work these days. All it takes is the release of FED MINUTES which suggest that NO RATE CUT is likely in the short term and, hey-ho, everyone goes with the idea that the U.S. economy must have bottomed. The fact that no RATE CUT is in the offing, that wages growth is non-existent and that the U.S. Consumer may be optimistic but his credit limit is maxed out and that REAL CONSUMER SPENDING is not happening, were swept away yesterday in a burst of optimism. Or so we are told.

There was nothing particularly cheerful about relatively hawkish monetary policy guidance in the face of weaker economic activity. But that guidance was supposedly the foundation for the U.S. Stock Markets' rally yesterday. Stocks in the States ignored the sharp sell-off in Asia, ignored the fact that the FED acknowledged that the "slowing" in the Housing Market had impacted growth more than they had originally expected and swept on to make new records. Gee that was easy.

Meanwhile in Europe, with inflation relatively contained, the ECB is making noises about growth. Over here in OLD EUROPE growth is a big of no-no. We don't like it, don't trust it and have given powers to an INDEPENDENT Central Bank to deal with it. Well not exactly. The ECB's brief is to deal with inflation, of which there doesn't seem to be much, and the ECB appears to have extended that brief to include CURBING ECONOMIC GROWTH. We wouldn't want anyone to get too happy or too rich. Especially not the plebs. Keep those wages down guys or we'll come running after you with higher interest rates and then you'll be sorry. And maybe we'll hike anyway, just because we can. That old saying about absolute power never looked more relevant.

The ECB has already signalled that a rate hike has been pencilled in for next week's ECB meeting. This will take the Official Cash Rate up to 4.0% in the EuroZone, which is a very comfortable margin above an annual headline inflation rate of 1.9%. But the hawks at the ECB have been squawking recently and more rate hikes look likely before this cycle is over. An independent Central Bank, independent of the people, the economic data and totally divorced from reality, can be a terrible thing to behold.

Still for now economic activity in the EuroZone remains robust, which is more than you can say for the U.S. economy. Indeed, given the divergent economic and interest rate outlooks for the two areas, it looks like the recent EUR/USD correction is over. Or close to. The FED may not be easing but it's not hiking either and the ECB is.

The external accounts of the EuroZone are unremarkable, there is no major surplus and no major deficit, and the U.S. economy is still leaking cash all over the place. That is: the U.S. is still spending more money that it earns. And there has been no relief despite a fairly substantial USD depreciation. Indeed, there has been no improvement in the U.S. Trade Deficit for, oh, the last three decades or so. Something must be done. So now it seems the U.S. has decided that they may as well bring back direct currency market intervention.

According to an article in today's Financial Times: The Senate bill is to be introduced in the next month and will mandate the US Treasury to intervene in global markets if currencies become fundamentally "misaligned".

So the U.S. Treasury will be able to "operate" directly in Foreign Exchange markets. Hmm. When they do they won't be buying USDs, that's for sure. At least if, as it seems, the powers-that-be have decided that the reason the U.S. can't sell anything to anyone is all currency related. In the U.S. they like nice easy solutions to complex problems. Sell a few USDs against the Chinese Renminbi and, hey presto, problem solved.

This has to be one of the most naive and ill-thought out policy responses ever. But then the U.S. has neglected education for decades and the results show. After all President George W. actually managed to graduate from a prestigious university. So it's quick-fix, sound-bite policy and if anything goes wrong bring in the troops.

In the months ahead we could see the U.S. Treasury join the long list of potential USD sellers. I don't see this as a bullish USD signal. And it's not a great signal for U.S. inflation either. If the USD takes a hit imported inflation will spike. And, given that the U.S. still imports just about everything, having moved most production offshore, imported inflation is not something to be sneezed at. Yes, Ben Bernanke and his boys are right to underline the inflationary risks which are lurking out there. Because they are considerable.

Meanwhile the U.S. Stock Market is going with misplaced optimism and the only rational explanation seems to be: everyone is already short. As an explanation it's not that exciting. Oh, and U.S. economic growth is benefiting Corporate Profits exclusively. The only trouble with that last argument being that growth, such as it is, is nothing to get excited about. They may have clocked up an annualised rate of 0.6% in the first quarter of 2007 but that translates into a very, very meagre 0.15% growth over the quarter itself.

OIL 63.24
GOLD 662.30

Although it seems that the U.S. is still planning military ARMAGEDDON in the Middle East they have done a very good job of not talking about it recently. And, because the markets react only to what is talked about, both GOLD and OIL are listing.

What we do know, finally, is that Bush is committed to keeping U.S. Troops in Iraq for the next 50 years or so. For the stability of the region, you understand. I'm glad we finally got that out of the way. This "Bring the Troops Home" was getting tedious.

At some point revenue from the Iraqi OIL will start to kick in and everything will be OK. The only trouble with that little plans seems to be Iraqi hostility. Still, so far out of an Iraqi population of around 20 million 5 million Iraqis have ALREADY been either killed or displaced. So, given the efficiency of the U.S. War Machine, eventually that Iraqi hostility will either be dead or living in refugee camps. Problem solved. In a unique American way.

Everything is going to plan.

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