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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Monday, January 22, 2007

It's Geopolitics, Stupid !!

EUR/USD 1.2934 Hi 1.2979 Low 1.2923
USD/JPY 121.72 Hi 121.81 Low 121.20
AUD/USD 0.7887 Hi 0.7908 Low 0.7880
EUR/JPY 157.47 Hi 157.65 Low 157.04

While there is a whole army of guys sifting through the economic data looking for clues to the health of the U.S. Economy, aka the U.S. Consumer, the real action is on the GEOPOLITICAL front. And there sure is a lot of action right now. Although the U.S. would like to believe that it makes all the rules in the International Arena it appears that there are more and more players who don't hold quite the same view. And the belligerence of the U.S. Administration is starting to have real consequences. Unsurprisingly none are positive.

In the three months to November OPEC members sold 9.4 percent, or $10.1 billion, of their U.S. government debt securities according to Treasury Department data. This is a pity because the U.S. has a big savings hole and OIL producers have surpassed Asian central banks as the largest pool of global savings, accumulating an estimated $500 billion in 2006 alone.

Somehow I don't think it was concern over the U.S. Inflation rate which caused OPEC members to dump U.S. Treasuries. So stop watching the economic data and start following GEOPOLITICS because that's what's important right now. OPEC dumped Treasuries last year and the trigger was GEOPOLITICS not inflation.

The Republican newswire, better known as Bloomberg, tried to make the best of the news by suggesting that OPEC selling of U.S. Treasuries was all about falling OIL prices. That makes no sense at all. If falling OIL revenues left OPEC with less money to invest in the three months to November 2006, and remember during that time OIL prices were still close to historical highs, then a case could be made for OPEC buying fewer U.S. Treasuries during that period. But that's not what happened. OPEC was a NET SELLER of Treasuries. Which means that one of the biggest supply of funding for the bankrupt U.S. Treasury may just have dried up.

And this is happening when the cost of the IRAQI conflict is going through the roof. Oh and just when the Bush Administration is talking about its plans for a bigger and better conflict in the Middle East.

It's starting to look like some people might have a problem with those plans.

The Chinese and Russians may have voted with the U.S. on sanctions directed at Iran but it doesn't look like the Chinese are keen to give the U.S. a blank cheque internationally. On January 19 China launched a missile designed to bring down satellites. They succeeded and just two days later the Chinese announced their intention to review their Foreign Exchange Holdings. Coincidental timing? I doubt it. In the Financial Times Richard McGregor blithely notes that Chinese FX Reserves are "now mostly locked up in US Treasury bonds". Er yes. So that's another source of funding potentially down the toilet.

Meanwhile Senator Ted Kennedy is trying to arrange a boycott of the latest Bush Plan for the Middle East, aka the SURGE. He doesn't really have to bother. The real source of funding for the U.S. right now is external and it looks like the principal funders, with perhaps the exception of the Japanese, have plenty of reasons to withhold funding. That external boycott will be considerably more effective than any rearrangement of finance which Senator Kennedy can arrange.

So while all the tea leaf readers study the data they should perhaps pay more attention to International Cash Flows. Unless the Bush Administration radically changes course there seems to be early indications that AT LEAST SOME of the international capital available to fund the U.S. 900 billion external funding requirement might not be so readily available in the future. Indeed, it seems that that funding has already started to be withdrawn.

It could be that the Bush Administration is clever enough to find a way through the labyrinth. Perhaps they can succeed in Iraq, whatever the current definition of success, perhaps they can reduce the spectacular U.S. external funding requirement without triggering a domestic economic recession, perhaps they can arrange for the Japanese to provide even more funding in order to compensate for the likely funding shortfall from China and the already apparent shortfall from OPEC. But given the performance of the Bush Administration thus far, it is far more likely that they make a complete mess right across the board. Bad news of course for U.S. Financial Markets, for U.S. Stocks, Bonds and the USD. So same old, same old.

OIL 52.15
GOLD 633.90

There are mutterings in the market that Saudi Arabia is acting to keep the OIL price down in order to pressure their Iranian friends. Perhaps it's true. It makes a nice story. But if global demand for commodities was as strong as it is supposed to be the Saudi refusal to agree an emergency meeting wouldn't be enough to keep OIL prices falling.

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