Wednesday January 5, 2005 - 11:38:21 GMT
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Black Swan Capital - www.blackswantrading.com
It is about rates
It was a bright cold day in April, and the clocks were striking thirteen.
Interest rates are heading higher. I’m shocked I tell you. Just shocked!
"With the economic expansion more firmly entrenched, cost and price pressures were likely to become a clearer intermediate-term risk to sustained good economic performance," absent further interest-rate increases, according to the FOMC minutes, released yesterday, the Journal reported.
It was the engineering of the emergency Fed Funds rate, to save the world from the clutches of deflation (denying thee as the proper cleansing agent for economic sins past) that proved most impressive as bubble fuel. It’s now the long march toward the elusive “normalization” of benchmark interest rates that will draw Zeppelin-like comparisons from observers as long-bond prices head toward earth, I recently wrote in Currency Currents.
Despite the references to inflation a la the FOMC notes, I believe the Fed’s goal is more basic. They know they are behind the elusive curve in which real interest rates, based on our methodology of measuring such creatures, are extremely low relative to economic growth. Estimates of just how far the Fed trails the rate curve ranges from 200 to 300 basis points depending on maturity level and who you ask. Either way, Uncle Al & Co. made it clear it’s time to remove the bubble juice.
We didn’t need FOMC minutes to recognize that grinding sound of slowing liquidity—a gander at commodities prices would have done the trick.
[CRB Daily Wave Chart]
A few weeks ago, I shared a simple gold buy/sell zone chart with clients. It had entered a sell zone. I use it not to trade gold, but to provide background material to help me judge the direction of the dollar. But if we look deeper into the gold/dollar relationship in this cycle, I think we find China at the core. For it was the Chinese gold trading and commodity demand as far as the eye can see that was a major part of the story for the yellow metal. I have been concerned about overheating in China for sometime—as many have. But the evidence is mounting against this core driver of gold and all things raw; especially now that the lowly dollar emerged with an Atlas-like attitude so far this year.
These are some recent tidbits from Morgan Stanley’s Asian economist on the scene, Andy Xie:
“The negative sentiment towards the dollar was behind the sustained surge of liquidity into emerging markets, which kept emerging economies buoyant, mainly via surging fixed investment in China and the resulting high commodity prices for other emerging economies. The buoyant emerging economies caused the global economy to grow at the highest rate in two decades.”
“When the dollar bottoms, I believe it will signal the peaking of all risk assets globally (e.g., Shanghai property, commodities, and emerging market debt).”
“If the dollar reaches a convincing bottom in 2005, major reversals in asset markets could follow. The overvaluation of commodities and emerging market debt and stocks, for example, could correct quickly. A sharp slowdown in the emerging economies as well as the global economy would follow.”
Ding! Ding! Bing! Bing! Does anyone else here a bell ringing?
Emerging markets have been the darling of the hedge fund and mutual fund crowd on both the equity and fixed income side of the ledger thanks to the Fed’s squeezing the life out of the Fed Funds rate. But, Fed Funds are bounding back to life. We could be seeing a set-up for the classic self-feeding dollar rally where the dollar plays the role of both cause and effect i.e. if the players in the emerging markets get spooked, and they should be getting nervous at least, the flow back into the US will be another driver added to our list of good news for the buck.
Stranger things have happened. It is shaping up to be a very exciting year.
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