commodity prices crashing down around our ears

Foreign Currency Exchange Outlook : For the price of oil to continue south despite lower US stocks and despite a hurricane headed for the Gulf Coast implies extreme bearishness about the global economy. For gold to have fallen to the lowest price in a year implies a spreading fear of deflation. Declines in both oil and gold suggest that investors and speculators are getting more interested in recession-proof assets. For the financial sector to be leading global stocks downward means investors are starting to batten down the hatches.

All of this suggests that bonds should be the flavor of the day and we can’t expect yields to recover as long as fear is ruling. Since the US is the safe-haven bond of choice these days, the dollar can only gain as these trends gather momentum, which is nice for the dollar but an unhappy development for the Fed. The Fed would prefer to see rising yields since that helps the banking sector, which can get deposits cheaply and in the worst case scenario (a drop in lending), just buy Treasuries for a nice spread. Now that banks are de-leveraging and foregoing fees on iffy “products,” recovery in the financial sector should be painfully slow.
Longer run, of course, the US dollars “should” have a higher relative real yield, but for the moment, foreign exchange traders and investors are willing to overlook that. Look at pound to Japanese yen if you don’t believe it. Risk aversion has a powerful grip and can overcome even the juiciest of carry-trade spreads, at least sometimes.

That brings us to the question of whether the Fed would consider a rate cut on the grounds that a rising dollar is the same thing as tightening credit conditions. This is muddied by banks being unwilling to lend for reasons other than credit quality. Also arguing against a rate cut is the high inflation rate in the US, technically over 5%, although the Fed might argue that with oil and other commodity prices crashing down around our ears, we have to forecast falling inflation. (Note that we get fresh inflation data next Tuesday, although they are lagging and will not reflect the recent drop in commodity prices.)

Some observers imagined that Yellen, in remarks last week, suggested that ever-rising interest rates are not a foregone conclusion. We didn’t see it that way, but her comment was ambiguous. Nobody expects the Fed to take any action at next week’s policy meeting, but it’s conceivable, just, that we could get a more balanced outlook in the press release. If the Fed were to say the outlook for inflation has improved by a lot, it could put a serious dent in dollar’s uptrend. That would imply the Fed willing to ease while the ECB is still in full-dress hawk mode. It’s probably a remote possibility and yet we can detect the faintest whiff of such risk.

The most interesting aspect of it is where it leaves the UK, which seems to be siding (so far) with the ECB on fighting inflation and to hell with the fading domestic economy. The Bank of England seems to think it is stuck with falling activity and rising inflation and unemployment, but because it can see light at the end of the tunnel (in 2010), no rate action is appropriate.

Well, they are entitled to their opinion.

At this point, the deflation scenario has not yet captured everyone’s imagination. The market is in the grip of the chartists, and chartists have as their first principle the observation from Charles Dow that once a trend is in place, we expect to remain in place until something Big comes along to disturb it. Any suggestion the Fed might cut rates could be Big, but then again, maybe it’s not, since it doesn’t necessarily flatten the yield curve. Besides, lower rates promote whatever lending is left to get done, cheer up the stock market, and would show the world that the US is still on a growth path and not headed into technical recession. Most of all, it would show that the US is pro-active, unlike others. It’s a bit bizarre to say so, but a rate cut or rate-cut talk from the Fed next week would probably be dollar-favorable! And even if the Fed refrains from saying anything remotely lucid about rate levels potentially going down, we are pretty sure it will be increasing liquidity to financial institutions at quarter-end and year-end, which is almost the same thing, if without the announcement effect.

Today is the anniversary of the 9/11 attacks on the World Trader Center and Pentagon. Is there increased wariness and nervousness? Yes, probably, but it’s unwarranted. It’s those of us in the Western mode who think in terms of higher risk on an anniversary.

We have no evidence that the bad guys think that way, too.

Bye for Now

Barbara Rockefeller

Best Exchange Rates when you Buy US or Canadian Dollars

a cartel is a dangerous thing

The Oct NYMEX crude oil contract closed at $103.26, near the low of $101.74, which is close enough to the psychologically significant round number $100 to be really interesting. Even better, the price didn’t move much after OPEC decided to cut output a little, only to $103.48 by 6:13 am ET today, over a half hour since the OPEC story came out. OPEC will cut production by around 520,000 barrels per day for the next 40 days, or about 1% of supply and putting production back where it was during the first quarter, according to the WSJ.

What the WSJ fails to report is that when Indonesia resigned from OPEC, having become a net oil importer, OPEC lost “control” of its production of 865,000 barrels per day, so a cut has to be expected in the first place. Also, OPEC had been producing 520,000 above quota in July, according to OPEC president Khelil, as the “cut” of 520,000 is actually a confirmation of the existing quotas (in place since Sept 2007). In short, it’s not really a cut. Oil prices initially rallied on the production cut announcement (to $104.82) but then the the market got smart and realized OPEC had done as expected, affirmed existing quotas.

In addition, the International Energy Agency again cut its forecast for global oil demand in 2008 by 100,000 barrels and in 2009 by 140,000 barrels, due to global slowdown and changing consumer behavior. This pretty much leaves us where we were before, and with speculative demand deeply on the wane, the impetus for higher prices is defused.

Bloomberg reports that according to critic Masters, who runs a hedge fund and lambasted index managers in Congressional testimony in July, now says commodity index investors sold $39 billion worth of crude oil futures between the July record high price and Sept. 2. This is what is behind the drop in the price of oil.

His report will presumably be available to one and all today, thank goodness. His timing is terrific, since the CFTC has to present its own report to Congress tomorrow. The CFTC claims Masters doesn’t have the data he needs to make his case, but Congress has found him credible. Bloomberg says “He has been cited by lawmakers who introduced at least 20 measures to curb speculation.”

Masters says that Congressional pressure on the CFTC to step up enforcement and restrict anonymous trades has pushed index traders out of their positions. “I don't think it's just coincidence that the money came out after the pressure was put on these folks.''

Who are these people? It’s JPMorgan Chase, Goldman Sachs, Barclays and Morgan Stanley, who together control 70% of the commodities swaps positions, and swaps dealers are the largest holders of Nymex crude oil futures contracts, according to Masters. “These large financial players have become the primary source of the recent dramatic and damaging price volatility,'' Masters said in the report. The banks decline comment but realistically, they have to be in the grip of the lawyers and public relations folks at this point. We are inclined to think Masters is right and even if he isn’t, Congress thinks he is right. Speculators are certainly pulling back as we see from the price. Masters thinks it could be $65-70 in their absence.

And it is clear that the propensity to panic and shove prices higher on the slightest excuse seems to have fled entirely, or to have been overwhelmed by other considerations. Russia proposed to OPEC an "extensive cooperation" understanding that normally would have fallen like a bomb on the oil futures market. According to the WSJ, Russia says “the memorandum of understanding could take two months to sign, suggesting it could be finalized in October when OPEC representatives come to an international oil conference in Russia.” This is a high-stakes game.

Russia would not have disclosed the existence of a possible deal if OPEC had not already indicated it will get done… and yet what’s in it for OPEC in general and Saudi Arabia in particular to make pals with the “enemy” of its best customers? We put “enemy” in quote marks because it’s a strong word—maybe “adversary” is a better one.

The FT is much calmer about it, saying Russia is an “observer member” that doesn’t share in the voting or quota system. “The last time Russia cut its output in solidarity with Opec was in 1999, when Mexico and Norway also reduced their production to help boost prices that had fallen to 9 dollars a barrel.” So-called “closer cooperation” between Russia (11% of world output) and OPEC (40% of world output) is not cause for alarm, with OPEC having “recently held a relatively benign position and become a reliable supplier of oil to the world for more than two decades.”

But wait a minute—a cartel is a dangerous thing. OPEC has been a weak cartel, unwilling or unable to enforce quotas that many producers openly flouted. Any change that makes OPEC stronger as a cartel has to be a bigger risk to the consuming countries, not to mention the diplomatic aspects. The US is already concerned on Europe’s behalf that Russia can and does dominate the oil supply scene there. This is not ithe US interfering in other people’s business but rather a realastic assessment of potential future costs to the US. After all, to whom will Europe turn if Russia closes the spigot?

Bye For Now

Barbara Rockefeller

the euro fall under the previous lows

Foreign Exchange Currency Outlook : We don’t know what will happen to Lehman or whether it has a lasting effect on the financial sector landscape, let alone the US dollar. It seems that after the market accepted the Fannie/ Freddie conservatorship on Sunday night and took the US Dollar up instead of down, the Foreign Exchange market can swallow just about anything these days.

And that leaves us with housing and oil as the key influences on the dollar. The housing problem is getting fixed. Maybe it’s not getting fixed well or in accordance with some of the principles we’d prefer to see, but action is being taken and the sense of Depression-era dread is lifting. Yes, foreclosures are still rising and additional banks will fail, but overall, the US economy is going to survive this crisis.

Oil is falling. We guess that Masters is right and the threat of regulatory action against speculators (if it’s fair to call indexers “speculators”) has caused their retreat. They will go play in some other sandbox for a while. Demand has fallen with greater elasticity than we thought, and OPEC has behaved in a good-citizen manner. The only wild card seems to be Russia and its desire to bully Europe, but we have few doubts that a change in supply chains is in the works. This is exactly the kind of thing at which the US excels, or used to, behind the scenes.

This Panglossian outlook requires that the euro fall under the previous lows (1.4057 yesterday and 1.4044 the day before) and thus maintain its downtrend. The worst of all possible outcomes is not a dollar rout on the Lehman news or any other news, but rather a sideways move that fails to confirm ongoing trendedness. We need to see this week’s lows get broken by the end of the day Friday and by now have the luxury of being able to sit out a little sideways action as long as it doesn’t last into the weekend.

Bye For Now

Barbara Rockefeller

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Everyone is worried about Hurricane Ike

The Oct NYMEX crude oil contract closed at $106.34, only pennies from the close on Friday but still a bit higher, with the high at a higher level, too. Everyone is worried about Hurricane Ike, which could make landfall near the cluster of refineries near Corpus Christi—or elsewhere.

It has weakened to Category 1, however, and in Vienna, Saudi oil minister Al Naimi told the press ahead of the OPEC summit that “The market is fairly well balanced and we have worked very hard since June’s meeting to bring prices to where they are now… Whatever the customers want, we will satisfy.” Putting the cherry on the ice cream, Algerian oil minister and current OPEC president Khelil said “A production cut would not serve much of a purpose. Rather, it will damage the advantage the organization has got by making a positive gesture toward consuming countries.'' Khelil says there will not be a need for OPEC to meet again before the regularly scheduled Dec meeting.

The oil price obediently went down to $104.23 on these comments and is at $105.05 at 11:50 am GMT.

Bye for now

Barbara Rockefeller

US dollar continuing upward

Foreign Exchange Currency Outlook : With hardly anyone noticing, the focus in the market has shifted from relative interest rates to growth, and from monetary policy to fiscal policy. Nobody can imagine that the issuance of Treasuries that must, by definition, accompany the new funding of Fannie and Freddie is neutral, and yet nobody seems to care very much about the US budget deficit. Academics and fear-mongers, including such luminaries as former Fed chairman Volcker, occasionally jump up to warn against impending doom from excessive Federal deficits, and yet the machine rolls on with foreigners, including sovereigns, willing to buy this paper.

Some are worried (again) that the US is becoming Japan, deflation-ridden and overspending to the point of a ratings level on a par with Botswana. But the US in not Japan if only because the consumer is different. We always joke that Americans can be more materialistic because we have the space to store Stuff (thank you, George Carlin) and the Japanese do not have that luxury, but the deeper reason is endless optimism compared to other cultures, including Japan and Europe. This is why we do not save…. We think we don’t have to. There will always be a windfall.

This business of the government saving the housing sector is a fine case in point. How else to look at it other than a windfall for the vast majority of homeowners, which is the vast majority of Americans? Mr. Paulson may have acted in large part to maintain the reputation of the US among foreign investors, but the net effect so far is the rescue of the guy in Scarsdale or Scottsdale as much as the Japanese pension fund. Paulson is right that we have to figure out whether the government should be in the housing business at all, but in the meanwhile, we have relief. Of course the problem is just pushed off into the future, but that’s where we like our problems to reside.

This may not be a good way to run a country or a government or a society, but for FX traders, the temporary solution is the only one that counts. Monsters may be lurking under the bed (mostly in the form of reserve diversification), but if big investors don’t care about looming budget deficits and are happy to see the trade deficit contract, who are we to call them short-sighted? The long run is a series of short runs, said Mr. Keynes, and when it comes to trading, he’s right. If the market chooses to see a systemic risk deferred, that’s what counts, even if other risks are just as big or bigger.

After all, we have known for two decades (since the S&L debacle) that the GSE’s made no sense and were run wrong. Now somebody else will be running that market, probably a whole batch of private players, and that works for the US system. It may not work elsewhere, but it works for the US. It’s important not to underestimate the relief that accompanies acknowledging that such a giant change can occur in the US, over $5 trillion, and not rattle the world. In any other country, the failure of an government organization the size of Freddie and Fannie would have caused stock market crashes, a currency crash, and heaven knows what else. In the US, we have embraced the change and do not fear the future, which is sure to be fraught with problems—-but never mind.

This is why we see the US dollar continuing upward. The US is weathering a storm. Foreign Exchange Traders like that.

Whoever started the dollar rally Sunday night deserves a lot of credit.

Bye For Now

Barbara Rockefeller

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Commitment of Traders Report

CFTC Commitment of Traders Report: Market News reports that speculative accounts added to their net short euro futures positions to a total of 38,623 contracts from the net short of 33,778 contracts the week before. “This week's euro position is a record short and remains in sharp contrast to the net euro long position of +119,538 contracts, seen May 15, 2007 which was a record euro long.” As for the yen, speculative currency accounts cut net yen short position to -5,020 contracts from last week's position of -19,970 contracts. Only on July 15, speculative accounts had a net long yen position of 50,105 contracts. This “remains in contrast to the March 25 position of +65,920 contracts, which was a record net long yen position and June 26, 2007's net yen short of -188,077 contracts, which was a record short.”

In other words, traders are more confused about the yen than anything.

Bye For Now

Barbara Rockefeller - Click here to get a free trial of our currency trading report

the dollar knows no bounds

Foreign Exchange Currency Outlook : Former St. Louis Fed Pres Poole said Fannie and Freddie will probably have losses of about 5% of total assets, or $300 billion. Added to the $500 billion from the private sector already reported, we are nearly at the $1 trillion that the IMF estimated last year. Or is it $2 trillion, as Roubini says? This should be an underlying concern, although you’d never know it from the US Dollar action.

Foreign Exchange Traders are behaving as though the US Dollar can and will pull through this latest crisis, which is not only a vote of confidence in the US system but also a vote of confidence directly for Mr. Paulson. We thought he was being lied to by the Chinese and failed to get his agenda respected there, but he has come up aces on the Freddie/Fannie side. For the dollar to gain 265 points overnight, from 1.4429 to 1.4165, is the proof. Now that the euro broke support at 1.4366 and then 1.4311, an increasing number of analysts are saying the next point for a pause is probably the 62% retracement level of 1.3860. We also see the spike low of 1.3361 from last August or 1.3500 as a nice round number, and other estimates.

We say nobody knows where this move could end.

We get some potentially frightening data this week, especially August retail sales on Friday. Before then, barring an unhappy surprise, attention will be focused on the institutional factors, mostly Freddie and Fannie. Now that Paulson has proven his chops, his every word will get headlines, and rightly. We say the beginning of the end for Fannie and Freddie is a critical factor, and the dollar knows no bounds now.

Bye for Now

Barbara Rockefeller

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