The outlook for the US economy is certainly weaker as the Fed steps into a revive the government owned agencies - Freddie & Fannie Mae. These agencies were destined to fail, and highlight the extent to which these government-owned agencies have been used to bankroll US property market investment. Foreclosures will need to be absorbed by the market before we can expect any rebuilding of confidence in US markets. So we might ask - what is the direction for interest rates? The way I see it, something has to give, whether its:
The USD has been strong, though it remains to be seen if it will break 108.2. I think not given the weakness in the market. I think the Fed will lean towards a rate cut rather than concerns about inflation. Its first priority will be growth, and whilst it might talk about raising rates to deal with inflation, the reality is that most of the money supply imbalance will be corrected by insolvencies and reduced speculation (debt liquidation) rather than interest rate increases. Why? Because the Fed will be taking its time to raise rates. It will talk about it but the reality is - the economy always gets primacy. The case for this is stronger close to an election -even if Bernacke suggests otherwise. The notion that the Fed is independent is a crock. We just need a fall below Y105 to correct market perceptions.
The USD has experienced some strength lately, though I suspect that is about to come to an end around Y109. The USD did however convincingly break its downtrend, so that is reason for caution, however I would give it until the end of the month to prove otherwise. I believe the coming 2 weeks will be a bad one for the USD. I dont see stronger interest rates to support the USD. Might the US economy show some unexpected strength? Well we'll need to watch the indicators. Importantly the Dow Jones index is at a support level, and I suggest that is a basis for support.
The AUD is fairly strong at the moment due to the strong export revenues from coal, iron ore and gold, and metals in general. The agricultural commodities are also providing mixed support. This is one of the reasons why the AUD is strengthening against the NZD of late. The other reasons are the interest rate differential is opening up. NZ interest rates are showing signs of peaking and growing inflation pressures in Australia are prompting a desire by the RBA to increase rates. It therefore seems likely that the AUZ will sustain its premium over the NZD having breached the $1.25 historic cross rate, last reached in early 2006. Thats not to say I see the NZ central bank lowering rates significantly or at all. I think they have just as much need to worry as Australia. NZ'ers have never been good savers. Australia has a better track record on this statistic. So I do expect the AUD-NZD to continue its rise to about $1.33, but then I suggest there will be profit taking. This will have big implications for NZ in terms of investment - see here.
One of my readers from Japan Forum was highlighting the fact that the USD has been strong lately - contrary to my few that it could be heading to Y85. I retain the view, and gave him the following response:
The NZD has been having a rally of late. If you focus on the negative press you might have thought otherwise about holding NZD. The reality is that a weak domestic economy is good for the NZD since it undermines credit growth and domestic consumption, which in turn reduces imports, whilst exports remain resilient. NZ has the benefit of being a food exporter, so it should benefit more in future as we see more general increases in the prices of food. NZ produces little oil so there is some basis for weakness there. NZ is not a great story, but if you are looking for a interest swap (yield) proposition it makes a lot of sense, whether as a carry trade.
I have long argued that the AUD is moving towards parity with the USD. I can see the AUD rising as high as 1.05USD, however I remain to be convinced of that. Technically the AUD looks like gathering momentum, and I see the Fed keeping interest rates low in the lead up to the US presidential elections. Post-election I actually see US interest rates being raised aggressively, which will send the AUD into a tail-spin. So it will be a short term ascension for the AUD. I expect the Fed to start raising rates just prior to the election, if only to create the perception of independence. Who are they kidding?
The EUR-USD is set to rally again to USD1.60 based on technicals. The EUR is currently lying at USD1.55 support. -------------------------------------
The AUD has had a good run against the Yen as expected. Although I can see short term delays breaking Y100, I actually believe the AUD is going to return to its previous high of Y108. At this point it will be sold off. The outlook for the AUD is going to remain positive. Strong capital inflows is supporting the market, whilst high oil prices and higher interest rates are helping to curb spending. It doesn't get any better. Higher interest rates is required to curb imports, which paradoxically result in a stronger AUD. At some point (Y108) the traders take their Yen and run though, and the likely reason will be weaker outlook for industrial commodities. Iron ore & coal though look good, so do the agricultural commodities. Inflation remains a problem.
The USD-JPY has reached an important resistance level and appears destined for a sell-down. The USD has rallied to Y105, but it has yet to break out of its downtrend. The prospect of a higher US interest rates would be a possible reason for this to occur, however I dont see higher Fed rates just yet.
The chart attached shows the USD staging something of a recovery against the JPY. I see this as a short term recovery. So short term in fact that I think as we go into today's trading I am expecting the USD will be sold off. Why? Because the USD has retraced to the previous resistance level it breached. The next major support is Y85. It will go to that level because the market knows that in an election year the US government & Federal Reserve will be pulling out all stops to win the next election. It wont happen. Americans are waking up to themselves, and their cholesterol-free, low-sugar diets, and will have a reality check. So we are looking at a further 15% fall in the USD-JPY, which on top of a 8% rise in the EUR-USD, suggests we should be looking at a 7% strengthening in the EUR-JPY over the corresponding period, just as an arbitrary.
Looking at the chart its apparent that the EUR-USD is going to USD1.70, at which point it will do a double bottom. I would then expect it to return back to its normal trading trade. The technical reasons for this are the strong symmetry evident in the chart. The USD has a 'parityband' between USD1.20-1.35 and has traded within 35c of that band. I am sure the market will be looking to retain that symmetry. So the EUR-USD will be a good 'short' trade from 1.70, though based on prior history, we can expect a 'double top', just as it previously made a 'double bottom' in 2001-2.
Looking at the AUD-USD its readily apparent that the AUD is not about to fall back as many pundits are suggesting. In fact I would suggest its building momentum for an assault on 'parity' with the USD. Clearly breaking resistance at 95c is the next hurdle.
Contrary to the belief that the AUD will weaken because of softer global economic activity, I believe the AUD remain strong against the USD, and to a lesser extent against the JPY. By that I mean I expect the AUD to reach parity with the USD and for the AUD to eventually break Y90. I don’t rate the high personal debt levels in Australia or NZ as a significant obstacle, though they are certain to cause some domestic hardship for some borrowers and lenders.
The high debt level is actually a benefit. The market wants yield, and is not looking for any significant global growth, notwithstanding the opportunities to short term trade . High interest rates in environment of high debt means reduced consumption, particularly of imports. High mineral prices because of capacity constraints mean high export revenues. Paradoxically Aust is benefiting from strong prices because of its 'poor planning'. This is requiring huge capital investment in Australia, so personal consumption is weak, but investment in productive capacity is buoyant and will remain so. We might event expect the government to kick in with some public works (particularly transport infrastructure) once signs of softening emerge. Also expect strong Chinese direct investment in Australian mineral projects funded by China surpluses and motivated by the desire secure mineral supplies. Aust is a net exporter of hydrocarbons (because of LNG), so high oil prices only reduce domestic consumption, which is another plus. The Australian RBA needs to worry about inflation so I don’t see any softness on interest rate policy. Only downside is a few foreclosures but I don’t see a great problem since job losses will be minimal. I cant imagine a better looking economy.
When the food sector recovers from drought after rains last in 2007, we can look forward to stronger export earnings from the farm sector. That will be another strength, destined to drive the AUD to USD parity....but not yet. Consolidation first in the 80-90 range to USD.
Reading some commentary on the Australian dollar I seem to be at odds with most of them. The SMH asserts “The Australian dollar may fall 7% in the next two months as commodity prices weaken and global equities decline”. The AUD reached a one-month low of USD90.97 last Thursday, down from its high of USD94.98 on 29 Feb 2008 – last reached on 29 March 1984. The argument for a weaker AUD is “The commodity story from here will be mixed to negative and risk appetite is being unwound”. On that note I am in wonder – where is the risk:I have just one qualification – money supply growth in Australia based on statistics I downloaded on the weekend is very high. In fact its at historic highs. The positive implication is likely to be that the Australian government will reign in that money supply by raising rates, at a time when the Fed could possibly lower them more. The USA is going into recession, and more importantly it faces an election.
“Risk aversion remains the dominant factor holding back the Aussie against the US dollar” according to Commonwealth Bank chief currency strategist Richard Grace. I don’t disagree with this, but that is the basis of buying opportunities. The reality is that no where is there growth prospects, so true no one is looking for growth from Australia, however I think the agricultural sector will surprise the market. I also think yield rules in these conditions. Australia is also a significant natural gas exporter and commodity prices in US terms still look good if you agree that the USD is going to its all-time low of 85Yen. I would suggest that Australian commodity export capacity is alot more tangible than the USD banking system. The gold sector is going to be another great performer for Australia in coming years. The other factor supporting the AUD is likely to be efforts by Asian governments to boost their domestic economies in the wake of a weakening US economy. Its worth considering the capacity of Asian governments to do this:
If anyone has the capacity to lift spending its probably the USA, but I don’t expect it at a time of rising global inflation. I think the Democrats will raise taxation.
Lastly I want to reiterate - I dont see depreciation - but there will be alot of pain for holders of debt that is not fixed. You should have fixed your property loan rates, at least for the next 5 years.
The USD-JPY has recently found some support at 96.5Yen, though I still believe the USD is going weaker. I was actually surprised by how easily the 100 yen level was broken. Maybe it was just a reaction to the Bear Stearns failure, but I think the market is going to need more convincing that other financial institutions are not going to fail.
The following is a discussion I had on Japan Forum. Got a debate going on the outlook for the AUD against the Yen.
