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Thursday August 7, 2008 - 19:21:13 GMT
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Forex Blog - Confusing Commodity Bubble Bursting With US Growth

While I am not going to say markets have this one wrong, I will say that large price movements like the one down in commodities and up in US dollar have a way of creating their own realities that often do not hold up over time. 

I think we are in one of those periods currently as two key shifts in market position unfold and drive large shifts in asset prices and FX.  Call it deleveraging or risk reduction on the one hand and bursting of the commodity bubble on the other hand.  No matter what the financial press is reporting, financial institutions are reducing risk – unwinding exposure.  Indeed I can’t recall a time when hedge funds were less engaged in trading.  And as negative data has piled up in Europe ad Japan and doubts about China’s growth story emerged, commodities have cratered. And these strains have fed on each other as well as any long/short equity manager would know who was short financial and long energy stocks. 

And in the middle of the unwind price action has led to a new consensus – inflation is so yesterday and growth is so now.  More now than Paris, Brittney and Barak.

But looking at the dollar and US Tsys in the last week one would never know that there is a global consensus that downside risks to growth is the main danger.  Today Trichet more or less admitted growth risks were being actualized, though also not budging on upside risks to price stability over the medium-term.  Presumably the Bank of England came to a similar conclusion and is less inclined to hike rates (I doubt MPC’s Besley voted today to hike for instance).    

So where is the disconnect?  Well if global demand is slowing and has pricked the commodity bubble, why is the US economy getting a free pass?  Is it some stupid accounting principal applied to the business cycle of first in and first out?  My stupid accounting analogy is first in last out.  No other major economy has a balance sheet like the US (super dependent on foreign savings – private and public sectors).  And growth held up in Q2 because of net exports (less negative) and government spending…consumption lift from the fiscal stimulus was pretty ho hum.   Yes inventories were a surprise negative and could reverse in Q3, but I would not count on it.  Wal-Mart today said its July same-store sales already picked up a dropping off of spending from fiscal stimulus checks. 

But credit is not static…credit conditions are tightening.  Mortgage rates are rising.  Swap spreads are widening.  Credit conditions depending on how one measures them are now about as tight if not tighter than they have been since the Bear hunt in March. 

Look at jobless claims in the last two weeks – dreadful.  Okay today’s weekly number reflects the extension of unemployment benefits (those eligible counted as new claims – form of double counting).  But claims are a better snapshot of current labor market conditions than any other series including the far more ambitious BLS non-farm payroll survey.  Anyone else notice that the July payroll data showed no change in real estate-related employment and a gain of 2,000 in financial services.  And government jobs have been growing at an unsustainable clip offsetting some of the decline in private payrolls.  What is happening to state and local government fiscal balances?  Well federal gvt too?  They are cratering.  Anyone who knows anyone in the teaching profession from coast to coast knows about layoffs and this is at a time when teacher shortages should be arriving with baby boomers retiring.  Gvt employment will soon be a drag on payrolls. 

Markets clearly needed to build in more weakness in Europe and Asia into expectations (even emerging market standouts too).  But to assume the US outlook goes unnoticed is well scary.

The US will be first into a serious consumer=led, and lengthy, recession (much deeper than the one it finds itself in now).  Europe and Asia will flirt with recessions, but they suffer far fewer imbalances and as such could be in better position to weather the perfect storm that lies ahead for the US economy…they have positive private savings. 

Another observation I have is that markets are suffering from credit crisis fatigue…who cares about AIG and Freddie Mac dismal balance sheets when oil is down $25 in two weeks?  And Citi set a precedent today for buying out investors sold Auction Rate Securities as safe as gvt t-bills…get in line Street (this is a $300bln market).

Sadly this is a future with a broken banking system and in need of a long rest and recuperation at a detox center free of leverage and risk and well stocked with capital exercise machines.  At the end of the day the US gvt will have a much bigger footprint in US economic activity from housing to banking and like any prior major cyclical turns in politics and economics, this one was delivered by the private sector aided and abetted by lax regulatory agencies, unjustified confidence in derivatives and financial engineering, and Clinton and Bush administrations hell bent of expanding home ownership – something now that is clearly not part of the Bill of Rights.   

Also anyone who knows of a vacancy as CEO at a major US financial institution let me know – I have interest in making tens of millions of dollars downsizing…this is another no downside trade the best I can tell as most these contracts don’t require execs to buy stock of the firm they get hired by to dilute. And you get a few years to do it meaning tens of millions over several years which could mean a hundred million.  That is one sweet deal. 

David Gilmore

PS – I still hate stocks and the dollar and love Treasuries, gold.


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