Showing posts with label Ashraf Laidi. Show all posts
Showing posts with label Ashraf Laidi. Show all posts

Wednesday, February 15, 2012

How EU-US LIBOR Spread Reflects Health of Economy - Ashraf Laidi

How EU-US LIBOR Spread Reflects Health of Economy - Ashraf LaidiSocialTwist Tell-a-Friend
This video clip is part of an exclusive webinar with Ashraf Laidi discussing currencies, commodities, and intermarket analysis. Ashraf Laidi highlights how the EU-US LIBOR Spread reflects the health of the Eurozone economy.


DATE: Recorded December 1, 2011. After Market Close

DOWNLOAD FULL VIDEO: http://www.hamzeianalytics.com/Educational_Webinars.asp

ABOUT ASHRAF LAIDI
Follow on Twitter: http://twitter.com/alaidi
Website: http://ashraflaidi.com

Tuesday, February 14, 2012

Q&A with Ashraf Laidi: US Dollar Risk Appetite Common Denominator

Q&A with Ashraf Laidi: US Dollar Risk Appetite Common DenominatorSocialTwist Tell-a-Friend
Ashraf Laidi answers a question during this webinar's Q&A about the correlation and causation of the US Dollar to other currencies and equity markets around the world. This video clip is part of an exclusive webinar with Ashraf Laidi discussing currencies, commodities, and intermarket analysis.


DATE: Recorded December 1, 2011. After Market Close

DOWNLOAD FULL VIDEO: http://www.hamzeianalytics.com/Educational_Webinars.asp

ABOUT ASHRAF LAIDI
Follow on Twitter: http://twitter.com/alaidi
Website: http://ashraflaidi.com

Thursday, September 18, 2008

Implications of Gold's Rise Relative to Oil

Implications of Gold's Rise Relative to OilSocialTwist Tell-a-Friend
Ashraf Laidi

Over the past 8 weeks, we alerted clients that the gold/oil ratio would continue to recover from its July record lows as oil begins to underperform gold. The latter would recover as the dollar drops on deteriorating macroeconomic fundamentals and further erosion in financial markets, thus, triggering re-emerging expectations of Fed cuts. Ever since the gold-oil ratio bottomed to a record low of 5.8 in July-courtesy of soaring oil prices relative to gold, the rebound was inevitable, especially as the ratio was well below its 37-year monthly average of 13.0 (see dotted horizontal line).

The latest jump in gold oil prices to a 5-week high of $895 per ounce and the simultaneous dip in oil prices below $92 per barrel is consistent with the aforementioned analysis. The chart below shows each time the gold/oil ratio had bottomed, a rebound was accompanied with a US recession, Fed easing and dollar weakness (accompanied by rising gold). In fact, since 1972, each of the last five U.S. recessions was preceded by 20-30% declines in the gold-oil ratio from its most recent highs. (See attached file )

RATIONALE
During economic expansions, rising demand for industrial metals and energy boosts both oil and gold prices, thus leading to a rising or steady gold-oil ratio. But when substantial advances in oil are the result of supply factors (political risk, wars, acts of god, labor union action, OPEC action/rhetoric, refinery shutdowns and falling inventories), oil prices tend to overshoot, clearly outpacing any gains in gold in relative terms, producing cost and inflationary repercussions for importers and consumers.

The chart shows how bottoms in the gold/oil ratio (shaded areas) were followed by declining or contracting GDP growth. In each of those cases, the Fed was obliged to cut rates and the dollar sustained fresh damage.




1973-75 Recession
1974 quadrupling of oil prices triggered sharp run-ups in US gasoline prices and a subsequent halt in consumer demand. Resulting USD drop pushed gold up by 15%. But faster oil appreciation dragged down gold-oil ratio from a high of 34.0 in July 1973 to 23.2 in October of the same year, before extending its fall to12.2 in January 1974. By 1974-75, the U.S. and the major industrialized economies had fallen into recession.

1980-82 Recession
Tumbling dollar and record oil main culprits to the 1980-82 recession. Gold-oil ratio dropped from 15.3 in January 1979 to 11.4 in August 1979 due to a doubling in oil to $29 and a more modest 30% increase in gold.

The 1977-79 dollar crisis forced OPEC to further hike prices to offset FX value of oil revenues. Iran revolution endangered oil supplies, thus ensued a 200% increase in oil between 1979 and 1980, giving rise to the second oil shock within less than 10 years.

The Gold-oil ratio fell anew from early 1981 to mid 1982 as oil remained around the mid $30s while gold plummeted from the $830s territory to $400 on waning impact of Soviet-Afghan. In summer 1981, the gold-oil ratio dipped to a 4-year low of 11.4 amid plummeting gold and stable oil, then onto 9.0 in Summer 1982, in line with the deepening 1981 recession which extended into mid 1982.

1985- 86 Slowdown
In autumn 1985, the gold-oil ratio bottomed at 10.6 from its 16.9 high in February 1983 due to relative stability in gold & oil. 35% decline in gold-oil ratio proved successful in signaling the 1985-1986 slowdown and resulting Fed rate cuts in February-July 1986.
Unlike in prior cases of falling gold-oil ratios, GDP growth avoided a contraction partly due to the offsetting positive effects of 1986 oil price collapse following OPECs flooding of oil.
The same idea applied for the recessions of 1990-91, 2001-2 and the current slowdown which has yet to called a recession.

MORE DETAIL ON HOW THE GOLD/OIL RATIO IS USED CAN BE FOUND IN CHAPTERS 6 AND 9 OF MY BOOK.

Tuesday, September 16, 2008

Confluence of Dollar Top

Confluence of Dollar TopSocialTwist Tell-a-Friend
Ashraf Laidi

Risk aversion is increasing looking like a pendulum swinging violently, with both extremes signifying heightened fear, with the lowest point of the pendulum reflecting short-lived reductions in aversion. Barclays announcement to reject the purchase of Lehman, the confirmed bankruptcy of Lehman and Merrill Lynchs announcement to sell itself to Bank of America each signified a rapid reduction in risk, which was principally guided by broad dollar declines and yen rallies. Temporary relief in volatility and risk aversion were triggered by announcements from a group of international banks forming a $50 bln fund to save help troubled banks.

Careful with FIFO Analysis on Currencies
A major fundamental argument sustaining the prior dollar rally was that of First-In-First Out (FIFO), supporting the hypothesis of the US recovering earlier than Europe because it had preceded it in entering the global slowdown and has delivered more aggressive fiscal and monetary measures than the old continent. While this notion is partially true, it overlooks the fact the impaired US banking capital and broadening credit woes (in interbank market and hedge funds) are the main factors distinguishing the US challenges from those in continental Europe. Stated differently, the Eurozone patients may have joined the global intensive care unit well after the U.S., but it in no way suggests that their condition is more critical than that of the U.S. Consequently, the collapse of Fannie/Freddie and Lehman, and near collapse of Merrill Lynch exemplify the repercussion on the increasingly fragile consumer fabric and employment foundation. The argument for Fed rate cuts is not only aimed at shoring up liquidity or inter-bank confidence, but adding from what remains of the Feds firepower to the ailing economy.

A Cut in the Discount Rate or Fed Funds?
As in August 2007, the Fed may be expected to try markets reactions with a rate cut in the discount rate rather than in the Fed funds rate to further increase banks access to the feds lending window. The discount rate currently stands 25-bps above the 2.00% Fed funds rate, half than where it was before the beginning of the easing campaign last August. At a time when the Fed has tripled the period of term loans to banks and expanded the range of loans it could buy from banks, it only makes sense to lower the discount rate down to the Fed funds level. The Fed's inflation priorities are now largely overwhelmed by their obligation to save the financial system as well as the economy.



Since June, I have been predicting that the next interest rate change will be down than up, compare to majority of pundits who had expected rate hike. Here are the articles June 27 and June 18 .

Planet Alignment for a Dollar Top?
The charts below show confluence of macro forces acting to halt the dollar rally. US dollar index gives way at the 3-year trend line resistance of 80.70, while EURUSD stabilized last week at the major support of $1.3877, which is near the 3-year trend line (blue line) and 50% retracement of the rise from the $1.1638 low (Nov 2005) to the record high of $1.6036. Similarly, oil's decline has yet to breach the $98.66 support, which is the trend line support from the January 2006 low. Gold shows to have bottomed at $745, which is just above the key support of $730 support (previous resistance in May 2006) and the 50% retracement of the rise from the March 2005 low to this years fecord high.

The fundamental underpinning of these chart formations is emerging from the latest woes in Wall Street and from a possible reduction in the dollars yield foundation in the discount rate. We continue to expect 50 bps in the fed funds rate, with the most plausible scenario occurring between Tuesdays FOMC meeting and the October meeting. But we are not yet ready to pronounce the end of the dollars upward correction due to what may occur in European banks ties to Lehman as well as the macroeconomic weakness in the continent.

CHF and JPY continue to outperform across the board, especially against the wobbly USD and GBP. USDJPY seen capped at 106.20, with pressure pulling back towards 105.20 and 104.80. USDCHF eyes 1.1160, EURCHF eyes 1.5850, AUDJPY capped at 86.20, eyes 84.60 and 84.20.




Wednesday, March 5, 2008

Monthly FX Strategy

Monthly FX StrategySocialTwist Tell-a-Friend
Ashraf Laidi

Euro Momentum Remains Intact

The latest episode of Euro strength is underpinned by not only the breadth of the rally (gaining versus EUR, GBP and CAD) but is also founded on the unlikelihood that the European Central Bank will intervene to stem its strength. With inflation at a record high of 3.2%--well over the central bank’s preferred level of 2.0%--and oil prices surging above $103, markets are well aware of the anti-inflationary benefits of a strong euro during the soaring energy prices. And unlike in past episodes of Euro strengthening such as 2004 and early 2005, European politicians have shown remarkable coordination and cooperation with the ECB by tempering their complaints against the high currency, considering the ongoing slowdown in their economies. Such cooperation bolsters the credibility of the ECB and its president JC Trichet, in contrast to escalating criticism facing Fed Chairman Bernanke and BoE Governor Mervyn King.

But the Euro has more going in its favor than simply credibility and containing costs of rising oil. Two consecutive increases in Germany’s main business and investor sentiment surveys (IFO and ZEW) defying expectations of a decrease have played a major role in validating the monetary policy contrast to the Federal Reserve, Bank of England and Bank of Canada. The Euro is also boosted by the lowest net interest rate disadvantage since December 2002 against the top traded 7 currencies (USD, JPY, GBP, CHF, CAD, AUD and NZD), in contrast to the US dollar whose net interest rate disadvantage is at a record high, beating the levels of 2003-04 when US interest rates drifted at 45-year lows of 1.00%.

Another reason to expect further gains in EURUSD is the historical ways in which the pair has added to its gains each time it broke key figures; $1.20, $1.30, $1.40. This leads us to believe that $1.5400 maybe in the works as early as this month, especially in the event that the Fed opts for a 75-bp cut on March 18. A subsequent retracement later in the month is expected to stabilize at $1.5250 as jawboning from European politicians and policy makers is seen on the rise.


Yen Marshes Onward Seasonally in March

Shaky global investor confidence and deteriorating USD sentiment is expected to continue boosting the yen during the month before temporary stability in April and May. The yen’s historical strengthening during the month of March in light of pre-fiscal year-end repatriation by Japanese firms and institutions is likely to test the 102.30s. Markets will continue shrugging jawboning remarks from Japanese officials until policy makers are forced to threaten operational intervention, which has not been done since early 2004. One main reason Japanese officials have stayed away from intervention is the avoidance of accusations of a double standard, as the industrialized world has largely criticized China on its interventionist approach to keep the yuan from strengthening more rapidly. Another reason to the lack of interventions is the fundamental backdrop to the current gains, especially against the USD. Japanese officials have long stated that the impact of US sub-prime losses was limited in Japan and praised Tokyo’s ability to stave off the costs of yen strength. Therefore any remarks from Tokyo are unlikely to carry much weight without the threat to follow up with real intervention.


This week’s US labor report as well as the FOMC decision later this month will act as major possible determinants of the fate of the 102.00 figure. Unlike last year when aggressive Fed cuts weighed on the Japanese currency to the benefit of the USD on the argument of rising risk appetite, aggressive rate cuts today are largely seen to the detriment of the already floundering interest rate foundation of the greenback. Upside remains capped at 105.








Sterling Crosses Remain on the Wane

The fact that cable’s gains have largely emerged on USD weakness highlights sterling’s own weakness, especially as the currency has hit 11-year lows against the euro, 5-year lows against the Swiss franc and 7-year lows against the yen. The deteriorating landscape in UK housing as well as eroding public finances are seen spilling over to consumer demand, thereby, capping inflationary pressures and paving the way for further BoE easing. The proposed tax levy on non-domicile residents in the UK has already been received by threats from foreign workers to leave the UK. If the law is passed, it should accelerate home sales in up market real estate areas, thereby, exacerbating the decline in UK housing.

We expect three more rate cuts this year, bringing down base rates to 4.50% as the deteriorating picture in the housing market and public finances spills over to the private consumption, capping inflationary pressures and paving the way for BoE easing.

Sterling’s plays remain most attractive on the crosses, against the higher yielding AUD and more fundamentally sound EUR and firming CHF. Cable seen retreating to $1.97 while EURUSD seen above $1.52, implying further gains in EURUSD past the 0.77 level.


Loonie Hurt by BoC Words and Action

Today’s Bank of Canada decision to cut interest rates by 50 bps to 3.50% following yesterday’s release of weaker than expected Q4 figures confirms our recent bearish CAD calls versus EUD, AUD and even the USD. CAD’s post-decision sell-off accelerates after the BoC indicated “intensifying” and “significant spillover effects” from the US slowdown. The US-element implies that ongoing US data weakness will drag CAD crosses in the future, thus highlighting our stance favoring EUR, AUD, CHF and JPY against the CAD. While we cannot ignore the positive impact on the currency from rising oil prices, we can deduce that any periodic retreat in oil will be especially punishing for CAD. Another negative for the currency is the current account balance’s descent into deficit territory, which removes an important positive element to the currency’s safe haven status. USDCAD is seen remaining underpinned at the 0.9850 trend line support, eyeing parity before middle of the month. We also see rising probability of 101 in CADJPY ahead.



Aussie’s Waning Momentum

Short term sentiment may be working against the Aussie in light of the overnight RBA decision to raise rates to 7.25%, which was accompanied by a statement indicating "substantial tightening in financial conditions since mid-2007". The statement implies that the central bank will wait and see the impact of previous rate hikes combined with slowing global growth filter through the economy. Last night's unexpectedly flat reading in February retail sales was the second monthly deceleration, further signaling that private demand is starting to wane. The highly leveraged Australian consumer has already faced 13 rate hikes. But the price surge in wheat and copper continues to benefit overall growth. Markets will await the release of Australia’s February jobs report, which will be vital in influencing future interest rate expectations. Finally, the market requires evidence from Q1 CPI report before concluding whether the rate hike campaign has ended.

The neutral tone of the RBA policy statement and the sharp slowdown in February retail sales will reduce some of the positive bias enjoyed by the Aussie, thus, likely reducing the currency's potential to rebound from risk reduction episodes. But the ongoing rally in commodities as well as the robust yield foundation will likely provide decent demand for the currency in the current low yielding environment.

Sharp pullbacks in equities could potentially drag the Aussie to as low as 91 cents vs the USD but deeper declines vs the JPY at 92 yen. But renewed bouts of risk appetite will offset the downside currents as long as further rate hikes have not yet been completely ruled out. But we should not discount the Aussie’s high yield stance, which is and of itself a positive element underpinning the Aussie back towards 93 cents by month-end.

Thursday, January 24, 2008

Margin Data Suggest Prolonged Bear Market to Come

Margin Data Suggest Prolonged Bear Market to ComeSocialTwist Tell-a-Friend
Ashraf Laidi

One essential indicator for the future performance of US equity indices is the aggregate margin debt used by member firms of the NYSE. After attaining a record high of $381 billion in July, member firms’ margin use continued to tumble for the following 4 months, reaching a low of $322 billion. Such declines in debt result from the execution of margin calls as client losses escalate to unsustainable levels, which is the case during mounting market volatility.

The chart below clearly shows that the rapid declines in margin debt from their record highs correctly predicted the prolonged bear market in equities in fall 1987, fall 1998 and spring 2000. The continued declines in margin debt in December to $322 billion from the July high of $381 billion suggests that continued losses are due in the market, which is consistent with our expectations for a prolonged bear market in equities. The 12-15% declines in stocks we predicted back in December are already underway. We expect another 15-25% of declines to come by end of H1 as the macroeconomic deterioration coupled with prolonged losses in US banks and profit warnings (no currency translation effect this time as the dollar stabilized in Q4-Q1) will overwhelm the easing measures of the Fed.

The importance of determining where the general equity indices are heading is highlighted by the 70-20-10 rule, which states that 70% of a stock’s movements are influenced by the broad indices, 20% are driven by stock’s sector and 10% by the fundamentals of the individual stock. As history has shown without fail, individual stocks have consistently followed the broad averages during prolonged bear markets regardless of their individual fundamentals.

Incorporating this outlook to currencies, continued risk reduction should maintain the yen as the key beneficiary of falling risk appetite and unwinding of carry trades. Further declines in USDJPY, GBPJPY and CADJPY are in store as we anticipate 103, 202 and 100 respectively before the end of the quarter.











Editor's Note: Do not miss Mr. Laidi's Q&A session with the Financial Times last week regarding currencies located at
http://www.ft.com/cms/s/2/34139f9c-c50b-11dc-811a-0000779fd2ac.html

Thursday, January 3, 2008

2008 Global FOREX Outlook

2008 Global FOREX OutlookSocialTwist Tell-a-Friend
Ashraf Laidi

The currency developments of 2007 were undisputably dominated by two main themes; risk appetites trades benefiting AUD, CAD, NZD, GBP and AUD at the expense of USD, CHF and JPY, and; USD-specific selling against all major currencies including JPY. JPY amassed broad gains during periodic episodes of risk appetite reduction as global stocks sold off aggressively in the midst of subprime-related losses in the US finance/banking sector.

The two performance charts below illustrate that USD was the broadest losing currency in 2007, while the top four performing currencies against the USD were CAD, AUD, EUR and NZD. The commodity currencies of CAD, AUD and NZD were boosted by a favorable price environment for energy, metals and agriculture as well as high interest rate policies. EUR was propped by its role as the anti-US dollar and by the European Central Bank’s persistently hawkish rhetoric. While the three commodity currencies were clearly in command in the ranking of currencies’ performance against gold, no currency registered any gains versus the metal, illustrating the secular rally in gold and other commodities. As we will see below, this suggests significant implications for gold in 2008 as the onset of low global real interest rates -wide is maintained by a rising inflationary environment relative to nominal interest rates.







Current Dollar Rebound to Continue Into Mid Q2 2008

The current 4% rebound in the US dollar index off its November lows is a broad USD play emerging on a combination of end-of year repatriation by US institutions and more pronounced signs of slowdown in the UK and Eurozone. Year-in-Year out, currency markets have shown a noticeable reversal in December of the trends emerging from mid October to mid November. This has worked consistently in favor of the euro against the dollar in December of 1999, 2000, 2001, 2003, and 2005 as the single currency declined markedly during the prior 2 months in each of those years. The opposite of this pattern took place in December 2006 as the euro lost ground, reversing the gains of October-November 2006. Year-end repatriation and unwinding of cash and futures positions are behind such seasonal moves.

Fundamentally, the argument that the Federal Reserve intends to stick to its newly adopted liquidity-injecting policy, rather than reducing the fed funds rate may be less detrimental to the US dollar, while the Eurozone is seen moving towards reducing its inflation hawkishness-an element largely responsible to the euro’s recent resilience relative to AUD, GBP, NZD and CAD. Finally, the interest rate cuts from the Bank of Canada and Bank of England have cemented the cap on CAD while accelerating downside in GBP, solidifying the foundation of the USD rally.


Sources of Prolonged Dollar Rebound

1) Despite market perception that the Fed’s liquidity injection measures are behind the curve in alleviating the credit crisis and that the lack of aggressive rate cuts remains insufficient in bringing the US economy to a soft landing, growing inflationary pressures in the short-term may bolster the central bank’s non-interest rate easing liquidity solutions for the struggling money market, thus, underpinning the dollar from a relative yield perspective. This would be especially USD-positive at the expense of GBP due to more ample downside for UK interest rates. More on BoE and GBP found below.

2) The extent to which the ECB’s intransigence holds rates steady in the midst of further economic slowing is perceived by markets to be exacerbating the existing economic slowdown, business activity and investor sentiment. Markets are also fixated on the next European victim from sub-prime investment such as IKB. Preliminary reports of EUR 5 billion in writedowns from IKB banks have not bee followed by subsequent announcements from other banks.


A Repeat of 2001?

As the dollar strengthened in the last 6 weeks of 2007 despite prospects for further Fed cuts, the unavoidable question becomes whether 2008 will be a repeat of 2001, when markets rewarded currencies of growth-oriented central banks? Two business days into January 2001, the Fed delivered an inter-meeting 50-bp rate cut to start a 475-point rate reduction campaign which took the Fed funds rate to a 45 year low of 1.75% by end of the year. Although the Fed funds rate dropped below the overnight rates of all G7 nations with the exception of Japan, the US dollar outperformed all currencies in 2001.
But one of the many factors distinguishing the current environment from that of 2001 is the purpose of the Fed’s easing. The rate cuts of 2001-02 were driven by conventional dynamics of macroeconomic slowdown (cooling business activity, weak GDP growth, rising unemployment and falling equities). Today, the Fed is forced into uncharted territory highlighted by the following factors:

1. A pronounced shortage of money market liquidity, unwillingness of lending by commercial banks, uncertainty regarding the size of remaining write-downs and the resulting impact on banks’ rating, capital cushion and bottom line. Tightening lending requirements for private households and business are also expected to weigh on overall capital formation and aggregate demand.

2. The macroeconomic impact of i) falling prices of new and existing homes on construction and consumer spending 2) falling sales of new/existing homes 3) increased layoffs in housing-related industries, banking/finance and manufacturing jobs, will impose a severe test on consumer spending once the post-holiday sales season is behind us.

3. The Fed’s task of shoring up growth will be complicated by persistent inflationary pressures that are unlikely to abate as was the case in past economic contractions. The prevalent inflationary environment originating from high food and fuel prices is unlikely to abate due to weather factors bolstering agricultural supplies and a combination of supply/demand dynamics propping oil prices.

Accordingly we project the Fed to deliver 100-bps more in interest rate cuts, bringing the Fed funds rate down to 3.25% by end of 2008.
Unlike in 2001, 2008 will be accompanied by the economic spillover of broad erosion in the housing sector, dictated by falling prices, sales, construction and layoffs in related industries. Robust growth from Asian economies should also help fill in the slack from the US and Western Europe, which will likely support the Eurozone’s external economy and stabilize the anticipated downdraft from the US.


Fed’s Liquidity Injection is No Substitute for Rate Cuts

Although the Federal Reserve has distinguished its monetary policy maneuverings between liquidity injection operations (aimed at relieving funding shortages in the money market) and interest rate-cutting moves (aimed at shoring up the economy), we do not expect these liquidity measures to stave off the risk of recession. While the Fed is seen extending the expansion of its discount window via the Term Auction Facility “TAF”, we expect it to cut the Fed funds rate by 75-bps in H1 2008, taking the rate down to 3.50%. There is likely scope for 50-bps of easing in H2 that will push the fed funds rate down to 3.00% by year-end. The inflationary repercussions of the Fed’s easing will remain an in issue for the central bank, especially as food and energy prices remain robust. Although the Fed has recently begun stressing the durability of price pressures on the headline inflation front (headline CPI and PCE), an anticipated deterioration on the macro economic front (rising unemployment rate, higher jobless claims, soft post-holiday consumer demand and slowing prices/construction activity on the commercial property front) will maintain the Federal Reserve’s policy bias towards the downside, as per its December FOMC statement and November forecasts for lower term inflation and higher unemployment for 2008 and 2009. This in turn is likely to limit the dollar’s rebound against the euro, especially in the event that the ECB succeeds in maintaining interest rates at 4.00% throughout 2008. More on ECB and euro below.


Gold’s Secular Rally to Continue in 2008

While the increase in gold versus the dollar in 2007 was largely associated with an acceleration of the dollar’s declines, the strengthening of the metal was broad-based throughout the year. Gold rose 27% against the USD, 26% against GBP, 22% against JPY, 21% against JPY, 17% against EUR, 16% against AUD, 10% against CAD and 8% against NZD, totaling 146% in gains for the year against the major currencies. The global growth-backed commodity story as well as emerging inflationary pressures played a significant role in gold’s advances.

One theme expected to continue triggering further advances in gold is that of real interest rates. The modest declines in gold relative to the more protracted and uninterrupted recovery in the dollar since mid November are due to falling bond yields. As the Federal Reserve, Bank of England and Bank of Canada blitzed the money markets with over $600 billion in liquidity injections in the last two weeks of 2007, market interest rates headed lower while inflation continued to push upwards. Persistent liquefying operations of central banks are likely to highlight the luster of the precious metal relative to paper currencies, especially as the real cost of money is dragged down by high inflation and lower interest rates. The inflationary consequences of these expansionist monetary practices coupled with persistent robustness in commodity prices are expected to offset any downward pressures on inflation resulting from cooling economic activity. While the relationship between strong commodities and cooling economic growth may prove untenable, agriculture, energy and metals are likely to remain supported by supply constraints rather than demand factors.

We anticipate real US interest rates to remain pressured by a combination of an expansionist Federal policy and robust energy pressures. This should continue to reward gold versus the US dollar as well as the rest of the major currencies as inflation remains at the upper end of the targets set by most G10- central banks.

But the $900 target isn’t expected to be realized before a temporary decline to as low as $720. Periodic bouts of reduction in risk appetite are likely to trigger episodes of profit-taking in the metal. The expected pall on the metal is also expected to emerge from a modest slowdown in Chinese demand for commodities. The People’s Bank of China’s policy tightening coupled with the yuan’s 10% appreciation as well as the slowdown in the US, Canada, Eurozone and UK is likely to temper China’s appetite for metals and energy.


No Need for Textbook Recession Definition

While there has been much emphasis on whether the US economy has entered (or will enter) the textbook definition of recession --two consecutive quarterly GDP growth declines-- the consequences to the overall economy are sufficiently worrisome in the event of a back-to-back quarterly GDP growth of between 0.1% and 0.3%. The 2000-2001 recession was such an example, when GDP growth declined by 0.5% in Q3 2000, rebounded by 2.1% in Q4 2000 before contracting by 0.5% in Q1 2001. A subsequent rebound of 1.2% in Q2 2001 was then followed by a 1.4% contraction in Q3 2001. This time the impact goes beyond sluggish manufacturing and a shrinking wealth effect from falling equities, and extends to tens of billions of losses in the books of banks, which carries ominous implications for overall credit and capital formation.


EUR: Further Downside Prior to H2 Recovery

The prospects of a durable foundation in the euro lies primarily on the European Central Bank’s focus on upside price risks as inflation exceeds the 3.0% mark, its highest level in 6 years. But with the ECB also recognizing that the balance of risks for economic growth are clearly to the downside, the central bank may be closer to easing interest rates than its inflation vigilance suggests. Although the ECB has been the largest injector of liquidity since August, these operations have been proven more helpful in relieving short-term funding for commercial banks than in assisting an increasingly struggling corporate sector. With the euro retreating 5% off its highs against the dollar, any dovish overture by the ECB may risk furthering externally driven inflationary pressures, especially as energy prices maintain their lofty levels.

But just as markets punish currencies whose central banks are seen behind the curve in containing inflation, they also drag down currencies when central bank policy is perceived to be exacerbating the downside risks to growth. Signs of a possible growth contraction in Spain and Italy in Q1 2008 may prove highly euro negative especially if the ECB shows no signs of shifting away from its hawkish stance. Germany’s IFO and ZEW surveys on business and investment sentiment continue to trend lower over the past 6 months reaching 2-year lows but still do not suggest an accelerating loss of confidence. Eurozone GDP growth is expected to slow to 1.9% in 2008 from 2.5% in 2007, surpassing US growth for the second consecutive year.

We expect the ECB to continue stressing the downside risks to the economy and the upside risks to inflation, while being forced to cut rates once to 3.75% and continuing to maneuver policy via liquidity injections and FX rhetoric. In the event of persistent credit constraints and deteriorating economic dynamics, any signs of a retreat in headline inflation towards the 2.1%-2.2% range, accompanied by a decline in core CPI towards 2.0% from the current 2.3% will pave the way for another ECB rate cut. Further downside ground seen testing $1.42, while the risk of accelerating losses is projected to stabilize at $1.37. Renewed gains seen emerging in early H2, retesting $1.48 before claiming $1.55 in Q4.


JPY: Benefiting from Lower Carry Trades

Chances of further yen gains in 2007 will hinge on the interplay between further unwinding of yen carry trades and the onset of slowing demand from Japan’s major trading partners. Our expectations for further dislocation in US equity markets as well as prolonged uncertainty in global credit markets support the case for renewed yen gains as risk appetite remains under pressure and global liquidity is curtailed. And although futures speculators have boosted yen long contracts to 2-year highs against the dollar in early December, there remains wider scope for yen buying amid fresh revelations of write downs from US banks.

But we must also heed the yen’s downside risks from the downdraft of slowing growth. With 22% of Japanese exports going to Newly Industrialized Asian Economies (Hong Kong, Korea, Singapore and Taiwan) and 21% to the US, cooling economic growth should cast a pall on Japanese exports, especially with the risk of a US contraction weighing directly on Japan and indirectly via Japan’s trading neighbors. China’s absorption of 15% of Japan’s exports does play a significant role in filling the slack. But the downside risks to China’s economy may provide an indirect negative spillover on Japan, thereby exacerbating the already slowing demand from the US. With the combination of lower US demand for Chinese exports, a prolonged correction in Chinese equities, the transmission effect of the People’s Bank of China’s rate hikes and further strengthening in the yuan, the risk of a region-wide slowdown can be significant.

Internally, Japan’s 2008 GDP growth is seen slowing to 1.7% from 2.0% in 2007, still within the nation’s potential growth range of 1.5%-2.0%. We expect the combination of increased market volatility along with the onset for 100-bps of Fed funds rate cuts in 2008 to redefine the playing field for global carry trades. As a result, 110 yen is seen as the new anchor for USDJPY before retesting the 105 figure in late Q3.


GBP: Further Losses Ahead

The British pound’s breach above the $2.00 level may have been the only positive story for the currency in 2007. But even against the dollar, sterling gave up most of its 9% gains to end the year barely in positive territory up 1.0% against the greenback. The currency was the worst performer among G10 currencies after the US dollar. We anticipate continued losses in sterling as the Bank of England is seen cutting rates by 100 bps throughout the year.

Although official and IMF forecasts project 2008 UK GDP growth to slow towards 1.9% from 3.1% in 2007, the risk of a more protracted housing correction may drag growth down to 1.5% for the year, with the risk of recession an increasing possibility. The domestic savings ratio fell below zero, a level not seen since the late 1980s while household debt service soared to 14% of incomes, the highest since 1991. With over 1 million of fixed rate mortgages due for reset next year, the risks to the personal debt market are considerable. UK estimates place the number of homes to be repossessed in 2007 at 30K and 45K in 2008, the highest since the property crisis of the 1990s.
The Bank of England had already been forced into a unanimous decision to cut rates in December, one month earlier than it predicted at the November inflation report. We expect the BoE to cut by 100 bps in 2008, taking down rates to 4.50%, which would deal sharp erosion to real interest rates, currently at 3.40%.

Sterling weakness will be a major theme in currencies for 2008, which should help the US dollar obtain some stability. This also means further divergence in GBPUSD away from EURUSD, which should trigger further strengthening in EURGBP. GBPUSD downside is seen extending through $1.92, with the risk of extending losses towards $1.88. Upside remains capped at $2.06. Further carry trade unwinding is likely to drag GBPJPY towards 210, with downside acting on $235.00.


CAD: Limited Downside from the US

The Canadian dollar was the highest performer in 2007 among all G10 currencies thanks to rising prices of energy and agriculture products as well as robust economic growth resisting the downdraft from the US slowdown. Currency strength and retreating manufacturing activity did force the Bank of Canada to cut interest rates in December, partially due to some help from cooling inflation.

GDP growth is seen edging up to 2.8% in 2008 after an estimated 2.5% in 2007. With 80% of Canada’s exports going to a recession-bound US economy, the negative risks on overall growth can be significant. The 8% share of total exports going to the healthier Europe and Japan may help offset the situation. But the composition of exports is also crucial. Considering agriculture and energy exports make up over 25% of Canada’s exports, or 10% of GDP, the sector make up is expected to help the situation especially considering the expected favorable climate for commodity prices ahead.

While oil prices will continue acting as the wild card, we do not foresee any prolonged declines below the $70 level. Steady prices should be CAD-neutral, leaving the currency equation to be determined by inflation and BoC policy. We see a 100% chance for a 25-bp rate cut in Q1 2008, followed by another similar move in Q2 that will take the overnight rate to 3.75%.

Unlike most of its G7 counterparts, Canada’s currency remains characterized by high real interest rates, standing at 2.7%, versus 2.1%, 1.0% and -0.6% for the US, Japan and Eurozone respectively. Although real UK interest rates stand at 3.4%, expectations of 100-bps in BoE rate cuts have already began weighing on the British pound.

We expect a 25-bp rate cut in Q1 to boost USDCAD to as high as $1.070 as the currency sustains losses from a combination of risk reduced risk appetite and falling yield differential. One more rate cut in Q2 to 3.75% may be needed by the Bank of Canada to stave off further slowdown, but as long as the market deems these cuts as precautionary, there is upside ground for a CAD recovery in H2 towards the $US 0.95 level.


AUD: Yields & Commodities to Counter Risk Aversion

The unwinding of high yielding FX carry trades and the broad USD rebound in the last 6 weeks of the year has overshadowed the strengths of the Australian dollar and the currency’s potential to retest parity with the USD. Standing at 23-year highs versus the US dollar in November, the Aussie was 6 cents away from parity as the Reserve Bank of Australia raised rates to an 11-year high of 6.75% and signaled to do more. We expect the RBA to raise rates by 50-bps in 2008 to stem an accelerating inflation rate, already projected to exceed 3.00%, well over the central bank’s preferred target of 2.0%-3.00%.

Baring any negative price shocks in agriculture and minerals, the Australian dollar is set to be amid the highest performing currencies in the G10 in 2008. In addition to a strong yield foundation, the currency stands to gain from a favorable price environment for commodities, as the sector makes up 65% of exports. Specifically, grain prices are widely expected to pursue their upward run in 2008, delivering higher returns for wheat and barley. And with minerals making up 50% of overall exports, steady demand for items such as copper --propped by China’s power generation capacity --the benefits would combine price and volume. The latter is also expected to soften the shock from falling US construction expenditure.

Another likely boost for the Aussie is the exposure of Australia’s exports to a robust regional market. Over 40% of Australia’s exports are destined to Japan (19%), China (14%) and the Republic of Korea (8%), all of which are expected to maintain their robust expansion in 2008. Yet even, a modest cooling in these economies is unlikely to pose any headwinds for the currency.

The downside risks to the Aussie include a prolonged decline in commodities prices resulting from a global growth slowdown and extended bouts of risk appetite hitting global investor confidence as well as high yielding currencies. Accordingly, these dynamics may drag the pair down to as low as 77 cents. But as long as the RBA retains growth and inflation arguments for a tight policy, we expect the Aussie to maintain its potential to rebound from risk aversion declines. Further Fed easing will likely lift AUDUSD past the 90-cent figure and test 95 cents by Q3. Chances of seeing parity in Q4 stand at 70%.

Thursday, December 20, 2007

Currencies, SWFs and our Stock Market

Currencies, SWFs and our Stock MarketSocialTwist Tell-a-Friend
Ashraf Laidi

I pretty much agree with Frank Barbera's outlook but not necessarily as bearish on the US Dollar in 2008. I think the Greenback will continue showing resiliency vs the British Pound, Kiwi and Aussie into mid Q2 before it starts to weaken again. Euro should start recovering after Q2.

As for our Stock Market, when you consider that the main catalysts to the recent gains were 1) Abu Dhabi buying part of Citi 2) rumors/hopes of aggressive Fed cuts 3) Bush rewriting legal contracts on mortgages, all of these factors fall under the "extraordinary items" category on which the ailing market cannot always count on. Unless of course, Arab Gulf SWFs, will alternate with Far Eastern SWFs every other week to announce new buyouts. The 2002 lows in stocks should come around by next summer.


Editors' Note: Ashraf Laidi will publish his 2008 outlook very soon.

Tuesday, November 13, 2007

Commodity Currencies Need a Break

Commodity Currencies Need a BreakSocialTwist Tell-a-Friend
Ashraf Laidi

The relationship between stocks and commodity currencies of Australia, Canada and New Zealand is taking an usual turn today, whereby equity indices are rising and these currencies are falling behind relative to the rally in EUR, GBP and CHF. One explanation is the weakening outlook for world growth, which is weighing on oil and gold prices. Talk of a potential supply hike from OPEC is sending oil below $93 per barrel while gold struggles just above the $800 figure.

We have already seen this broad weakness in commodity currencies last week after Fed Chairman Ben Bernanke predicted a “marked slowdown” in US Q4 growth. Another possible explanation is that currency traders are cautious from opening fresh dollar shorts ahead of this week’s G20 meeting of finance ministers in South Africa, where US Treasury Secretary Paulson is expected to receive considerable support for the “strong dollar policy”. Specifically, Canadian politicians have grown increasingly vocal in their complaints about the strong Loonie, which caused Canada the biggest burden of this year’s decline in the dollar. Last week, Canada’s Finance Minister Flaherty said he and Bank of Canada Chief Dodge will be having currency discussions with their G20 counterparts.








Considering the aforementioned risks against commodity currencies and our expectations for further erosion in US and global equities, we expect the unwinding of yen carry trades re-emerge against CAD and NZD and to a lesser extent the AUD (because Australia’s fundamentals are powered by an increasingly hawkish RBA).

November 15: Another August 15?

The next bout of equity selling could emerge on November 15, which marks the last day of the 45-day notice period at which clients should notify hedge funds to withdraw their money. With the broader market down nearly 7% since the beginning of the quarter, clients may take some money off the table as was the case in Q3 when August 15th was marked with massive selling across all equity indices. At the open of August 15, the S&P500 was down 5% since the beginning of Q3. Today, the S&P500 is down 5.7% since the beginning of Q4. In this case, we expect renewed rallies in the yen crosses and for the Aussie, Kiwi and Loonie to come under renewed pressure. The fact that the VIX measure of volatility stands at 2-month highs and the S&P500 is below its medium and long term averages (50, 150 and 200 day) underlines lingering preoccupation in the market. Given the technicals in the US benchmark indices and the ongoing repricing of MBS via credit rating downgrades, we expect the indices to retest their August lows. This means that another 5% decline in the S&P500 is in store.

Wednesday’s release of the October retail sales report is expected to show a 0.2% increase following 0.6% in Sep and a 0.3% rise in the core figure following a 0.4% rise. But given last week’s dismal reports on store sales, we do not rule out a decrease of as much as 0.2% in the headline rate, in which case will be the confirmation for Dr. Bernanke that the erosion in housing has begun to show in consumption. A resulting selloff in equities is likely to boost the yen and affirm the aforementioned forecast against high yielding/commodity currencies.

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