Sebastian

Manufacturing sector tends to be the first victim in a recession and an over-reliance on it is not necessarily a good thing, all the more so if the economy is export-oriented and the recession is a global one. Japan and Germany spring to mind as being high risk, while China will also suffer significantly from a more protracted global slowdown. Canada has oil reserves and oil production and while it benefited the Canadian Dollar last year, it has not done so since oil prices went over $100 a barrel. The US does not produce enough oil and indeed its reliance on oil imports has hampered the dollar badly this year. £ has some oil some big oil companies and rising oil prices is generally good for the £ - thanks to flow of funds into £ from other currencies. Plenty of debt laden types in US also where there is a negative savings ratio and now plenty of negative equity.

Brave move in the current market. It is due for big correction though. You need to be watchful of the yen because that has begun to bite again and AUD/JPY is still trading at over 7Y higher than at the time of the last collapse of the carry trade in March. A strong yen will hurt AUD/USD even further. The NZD is at a 2-year low against the yen which would seem to suggest NZD/USD is a safer trade than AUD/USD, if there is such a thing in this market. Also, RBA is expected to cut Australian IRs in September, which will restrict the upside in AUD/USD as we move towards the end of this month.

All the high yeilding currencies: GBP, AUD and NZD have been sold off massively in the past 2 weeks and all are now trading at levels well below where they were at this time last year when US interest rates were at 5.25%. The AUD alone is down 12% in the past month. Usually, aggressive sell-offs of high yielding currencies has to do with a mass liquidation of carry trades, but these currencies always bounce back sharply when risk tolerance levels rise. Greed drives risk tolerance and greed never dies. I don't like the euro at all because it has become something of a proxy currency for the market and its rise was closely related to the rise in commodity prices. Also, it now looks like the ECB's rate hike in July was a huge mistake and if anything, it probably brings closer the date when the ECB will be forced to cut IR. I see the euro doing much worse than the pound over the next 12 months, because for the euro, it can be argued most of the bad news has yet to be priced in.

That is all very true, but my point is that there has been no dramatic shift in economic fundamentals since August 1st to today, over which time sterling lost 13 cents. The Inflation Report today is merely endorsing that which the market already knows. Currencies move primarily on interest rate outlook and if the market gets ahead of itself in raising IR expectations, then the currency will eventually correct to reflect the actual outlook. The prospect of a narrowing in IRs between the pound and the dollar is no different today than it was on August 1st. Sentiment has shifted over that time with a belated realistation that this is a global economic slowdown and not a US one and that for the most part explains the about turn in trends and the one-directional play of the market. But we have seen a lot of panic selling. There is probably zero chance of a Fed rate hike for the remainder of this year, so it won't take much in the way of bad news out of the US to reverse the current trend and see the dollar sold off again.

The pound is still 1.5% above the record low it hit against the euro back in April. I would not be too pessimistic about the pound against the euro in the long run, because there are lots of uncerain times ahead for the euro and diversification in the performance of the different euro economies is soon going to become a major burden for the currency and a problem for the ECB. Both sterling and the euro have got away with murder in recent months as markets turned a blind eye to the appalling economic reports out of both jurisdictions, in favour of trying to find reasons to sell the dollar. Both are paying the penalty now.

or at: http://todayfx.com/full_charts.html The problem with sterling is that once it dipped below 1.9337 on Friday last (the year's low), there was no known technical support below this level, which means it will fall until it reaches a point that the market decides to support it. Sterling has not fallen so quickly in such dramatic fashion since 1992 and it now appears it is being targeted by big fund speculators and it looks very vulnerable. The 13 cent demise since Friday August 1st constitutes something of a currency market crisis, with a total erosion of confidence in the pound. It is very surprising that it is not attracting any currency bids on value grounds after such a steep decline, but the traditional lack of liquidity in the market in August has no doubt exaggerated the collapse. I have no faith in sterling's future myself but I would not be buying the dollar against it at prices close to 1.86. Sterling should be able to rise back to at least 1.90, purely on the basis that the the dollar's rapid ascendancy is not justified on fundamental grounds.

I thought they were incredibly biased. The reality is that it could be a disastrous error to raise rates and this will play on the minds of some members over the next fortnight. They clearly sent a signal though that their bias lay with tightening policy and intended to keep their options open, so that if they do raise rates next month, they can claim to have warned the markets. I don't trust them at all as there is no clear conviction in their deliberations.

A lower trend rate of growth? Of course! The historical average trend rate had been around 3.0% per annum. We are now at 2.3% for Qtr 1 and 1.6% for Qtr 2 with worse to follow in the coming quarters. I also do not believe the ONS figures. They claim a rise of 0.6% in Qtr 2 retail consumption over Qtr 1, but most business surveys and reports from actual retailers don't substantiate that, i.e. it was a lot worse in Qtr 2.

Well, if it is the case that the curent spike in oil prices is driven by fear and speculation more than real demand, then it will not last and what goes up will come down. Inflation will in this case moderate. This is what the Fed believe and in fairness they should probably know because oil prices doubled in price in the 9 months during which they cut interest rates by 325 basis points. It is not a coincidence that oil prices shot up at the same time as the Fed was aggressively easing monetary policy. They provided the space for the bubble to grow and are the ones who are really to blame for the current levels of global inflation. They are probably the only ones with the real power to ***** the bubble and for that reason it would be dangerous to bet against them.

There are a few reasons: 1) The GDP data was in line with expectations so should have little negative impact as it was already priced into the market. 2) Technicals. Sterling defended a technical price barrier at 1.9810 against the dollar on Thursday and had bounced handsomely off that to stand at 1.9880 before the data was released. 1.99 was previously a technical barrier on the downside, so once sterling managed to break above 1.99, it was going to sprint higher. On technical charts, GBP/USD is currently bullish or in an uptrend, so it is being bought on all dips. This will only change if GBP/USD ducks below 1.9810. 3) Sterling is benefiting from a temporary flow of international funds , which are going into sterling rather than the dollar or the euro, as uncertainty grows about the state of the US and euro economies. 4) There is a lot of concern about all major economies at present, not just the UK, so currency investors are placing bets on sterling in the very short-term because of its higher yield. 5) A hawkish statement by ECB member Liebscher this morning helped the euro to rally against the dollar. Sterling jumped on the euro's bandwagon. 6) The hawkish bias of the Bank of England minutes on Wednesday was a surprise and its significance is still reverberating across currency markets and many are betting the next move in interest rates will be up, and it may come as soon as August. This boosts sterling in the short-term. 7) Sterling has grown immune to negative economic data, in much the same way as the euro. Markets are too focused on the US and seem prepared for now to ignore the problems in the UK and in euroland. The worm will turn eventually and sterling and the euro will be made to pay for a stockpile of poor economic releases, at a time of the market's choosing.

Unfortunately the ECB is immune to growth risks and Trichet keeps repeating the mantra that they only have a single mandate, i.e. to maintain price stability. I remember a speech by Axel Weber (German member of ECB) late last year when he stated the ECB may have to increase interest rates even against a sharp economic downturn. The hawks are in a majority on the ECB Governing Council and it is notable that in the past 2 weeks, since the last ECB meeting, Governing members have failed to use the opportunity to express concerns about economic growth to the media and to try and downplay market assertions that another rate hike is imminent. Expect politicians to up the ante over the next 2 weeks.

With lower interest rates the US will climb out of the slump much quicker than the UK or euro area, if Bernanke is correct in his theory on moderating inflation going forward. The Fed has much greater experience than the ECB or the Bank of England when it comes to handling downturns, so we need to bear that in mind. Both the UK and euro economies are also in stagflation right now, just not to the same extent based on official figures to date. In reality they may be in a worse situation because the data over the past couple of months suggests growth is slowing at a faster pace in the UK and the euro area, than in the US.

It may be a small economy but the New Zealand dollar is a very important in currency markets, as it is the highest yielding of all the key carry currency pairs (EUR/JPY, GBP/JPY, AUD/JPY and NZD/JPY) and any Central Bank moves that directly affects one of the key carry pairs, has ramifications for them all. Also, the fact that a Central Bank of one of the developed economies has cut interest rates at a time when inflation is on the rise is important for Central Bank thinking at the moment. There are two camps 1) those that believe slowing growth will see inflation moderate in the medium to longer term and thus preclude the need for higher interest rates now - US, Canada, New Zealand and 2) those that believe current high inflation needs to be nipped in the bud either by threatening higher interest rates or by actually raising rates - ECB and the UK being the principals. All are on the verge of a recession, so only one of these two Central Bank groupings is correct in its policy thinking.

Demand for gasoline is apparently down 2.5% from this time last year, but the real signal that things are changing is that major auto manufacturers such as GM and Ford are in big trouble, as people are no longer buying gas guzzling SUVs and pick-ups. The issue with many of the developing economies is that the governments there have been subsidising oil imports and have thus protected their citizens from the sharp run-up in oil prices. Of course they can only do this for so long and the part-lifting of subsidies in Indonesia and in India recently led to riots. China still takes the hit on subsidies but that may all change after the Olympics. Now is not a good time to threaten the nation with a doubling in gas prices. Oil prices will plunge to below $80 a barrel if China and the other developing countries announce they will stop the subsidies. These countries will not be able to invest in the country's infrastructure if their surpluses go towards subsidising energy. Oil prices cannot be sustained at current levels, principally for this reason. There is already talk of India possibly entering recession over the next year. That would never have been believed this time last year.

New Zealand may already be in a recession and hats off to Bollard & Co. for cutting rates even while global inflation rates are rising. Central Banks should be focused on where inflation will be in 2 years and not reacting to spikes in oil prices, like the BoE and the ECB.

Inflation in the euro area had risen to an annualised 4% against 3.8% in the UK, even with the currency appreciation. Core inflation is contained below 2% in both jurisdictions and the headline rate has jumped almost exclusively because of imported oil and commodities, priced in dollars and not in euros. Inflation rose dramatically everywhere between August last year and June this year because oil doubled in price over this period. The euro rose 12% against the dollar during this time but even that did little to offset against the rise in imported inflation. The pound has not fallen all of 15% against the euro because of rate cuts by the Bank of England. It may have been a significant contributory factor, but it is only one of many.

Much will depend on the retail sales figures tomorrow and the economic activity indices due out at the start of August. It will probably take a combination of real shockers, or the imminent collapse of another Bank, to have them even consider a cut in rates. Despite the contractions evidenced in all sectors of the economy in June, the BoE did not even discuss the possibility of a rate cut at the July meeting, casting aside Mr Blanchflowers opinions.

That and the fact there are major market fears about euro data due for release on Thursday. Lots of traders have closed out in advance. Of course UK retail sales are also due for release, which are expected to be bad, yet it has not had any adverse effect on sterling today. The currency has grown immune to bad news of late.

You can get money supply figures from the Bank of England web site. Separately, public sector net borriwng figures are released on a per month basis, so you can look at the two and gauge what is happening. June's figures are striking and show the government massively stepped up its borrowing the previous month, which is a very worrying sign and suggests the government is desperately seeking to plug holes in the economy. Sterling's run will not last. In fact sterling's rise over the past month beggars belief when one looks at the economic fundamentals that have been printed out of the UK. The pound has been aided in the short run by a more hawkish sounding BoE, rather illiquid markets for the summer, a thirst for yield owing to the recent demise in equities and euro short covering with many investors worried the euro economy could fall very sharply in the coming months. Sterling is at a highly inflated level against the dollar and it could fall spectacularly. It could experience a very sharp fall from grace. I don't see sterling depreciating too much more against the euro, as both economies are facing similar problems in the quarters ahead and the euro itself has been way over-valued against the dollar all year.

Inflation is expected to moderate during a slowdown because 1) demand falls as people spend less, 2) retailers etc. are competing for a dwindling market and are less likely to raise prices and 3) With lower demand comes lower production and job losses. When jobs are being shed workers are far less likely to be able to get wage rises. Inflation could seriously undershoot in the medium to long term if oil and commodity prices collapse. This would remove the causal effect of the high inflation we see today. When we get to next January or thereafter, when we are comparing year on year inflation rates, we might be comparing months in 2009 with oil prices of $80 a barrel against months in 2008 when oil was at $130. If the slowdown is very dramatic and there is zero domestic inflation pressure, you could actually enter a period of deflation. Deflation is a nightmare prospect for a Central Bank. This is what happened in Japan.

The Bank of England also has a mandate to oversee growth in the economy, which the ECB does not. The current inflation rate would be much the same, whether the Bank of England cut rates or not. Core inflation has hardly budged this year, while headline inflation grew thanks to commodity prices. Today's minutes content was also leaked to certain elements of the market long before the minutes were officially published, which is another debate.

Money supply to the private sector has been slowing significantly in recent months, even with lower interest rates. It is public borrowing by the Government that made the numbers shoot up in June. As the Govt owns the Bank of England and essentially it prints its own money, it won't be persuaded by borrowing rates. Raising rates in a falling economy will only devalue sterling in the long run. While initially sterling may get a jolt from market speculators, if the Bank of England raise rates when the economy is slowing sharply, sterling is going to fall big time. The currency rose massively today, probably by the greatest amount this year, but those who have rolled into sterling for this short sprint won't actually last the distance. A base rate of 5% is significantly more than that on offer in most other major economies (4.25% in euro and 2% in US) and UK inflation at 3.8% happens to be lower than that in the euro area (4.0%) and in the US (5.0%).

August's vote could be the most interesting of the year. They want to hike, if just for the sake of saying they did not sit on their hands when inflation jumped to 4%. My guess is we will have 2 votes for a hike - throw in Sentence. If the economic activity indicators show further deterioration over the next fortnight and oil prices are contained, we could potentially have a second vote for a cut, though it is unlikely. The economy needs them to cut, but the Committee won't opt for that while most members are fixated on current inflation. If oil and other commodity prices follow the very recent trend and tumble while the economy continues to flirt with disaster, then this MPC will have a lot to answer for.

That man shorted oil in January and now he is long. The supply/demand arguments are the same today as they were in January but Pickens keeps repeating demand is 86 m barrels a day and supply is 85 million barrels. There have not been reported shortages anywhere that I know of so it seems supply is comfortably able to meet demand. I guess he is not too happy about the $20 drop in prices over the past 10 days.

It is huge news because it was thought if anything all dissent would have come the other way with possibly 2 members voting for a cut. It must be said however that it is not very encouraging as the Bank of England's hawkish stance is merely reactionary and they offer very little insight into how the economy may be dug out of the present hole. This MPC has always been biased to the hawkish side and it really is not a huge surprise that they should dither in the way they have. Headline inflation in the UK is imported and there is little the BoE can do about it, so threatening to raise rates to combat something they cannot confront displays a real lack of creativity, in my view. The UK economy is in a far worse state than the Bank of England seem to believe and their redundant stance makes it look like 1) they hope inflation will just disappear or 2) they are praying for some upside surprises in economic activity over the next month which might help justify an unwarranted rate hike in August. I have said it before about Governor King - he is the Central Bank Head of least influence over his Monetary Policy Committee. He lacks the decisive touch. Trichet and Bernanke maybe on opposite roads to Damascus, but at least each has a sense of conviction about what they are doing. King appears to be in limbo and is inclined to sway in the direction of the wind.