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Friday July 21, 2006 - 09:36:30 GMT
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“The reflexive relationship manifests itself most clearly in the use and abuse of credit.”

George Soros

FX Trading – Slowdown?

Bill Gross says the new bull market in bonds has begun. Funny thing is—we believe him this time.

US 10-yr Treasury Note Futures Weekly:

Why do we believe Mr. Gross? First, he’s a smart guy despite his call the Fed would stop about 100 basis points ago. Second, we buy the argument the Fed has done enough based on the evidence of a slowing US and global economy. Third, we tend to believe the yield curve most of all—it’s showing a “2-10” and “front door” inversion. “Danger Will Robinson,”—slowdown ahead!

Yield Curve:

Source: Bloomberg

And the “front door” inversion is when the Fed funds rate is greater than 10-yr yields:

Fed funds = 5.25% 10-yr Yield = 5.02%

Below is a summary of reasons for our belief in slowdown, which we have already shared with our Members. It’s a hodgepodge of research facts and assumptions cut and pasted from some sources we like. It’s an extension of Wednesday’s Currency Currents.

Slowdown themes

We believe there are signs that global growth is decelerating and could surprise on the downside. Central bank rate hikes are now biting into the consumption and we think beginning to take a toll on so-called “asset bubbles.”

In this environment, we don’t see a rebound in the metals to new highs, nor do we see inflation in the same light as the 70’s cost push variety.

We lead with the Employment Cost Index—Compensation chart courtesy of Hoisington:

With the mantra of “inflation” filling the air—it ain’t what it used to be. There is some passing on of materials and energy cost. But we aren’t seeing the wage spiral we once did. We chalk that up to the new global economy—billions of new and productive workers in China and India.

We think the Fed has done enough—if they go further, it’s another nail in the coffin for growth.

• China has blowout growth for the quarter at +11.3% annualize…but falling Foreign Direct Investment (FDI), down 12.2% in June

It could tighten up in China sooner rather than later:

“Efforts to cool the economy through monetary tightening and administrative controls on lending and property investment have met with limited success. In our view, continued capital inflows and hence the sustained availability of capital at low cost on the back of a currency appreciation expectation remain the key reasons, in our view. Moreover, local governments have assumed a dominant role in fixed investment. Their influence over local banks has undermined directions from the central government to halt lending and investment. We believe that weakening effectiveness of administrative measures in macro management will prompt China to shift towards more market-based standard fiscal and monetary policies.
“The government has started addressing excess liquidity in the banking system, through issuing bonds and bills. We believe that effective liquidity tightening will require a substantial rise in interest rates, as well as greater currency flexibility ahead. We reiterate that another interest rate hike appears imminent. We expect a 27bp increase in both deposit and lending rates this quarter, and another 27bp in 4Q06, “according to Danise Yam, Morgan Stanley.
And from Mr. Andy Xie:
“Softening global demand and rising oil prices are squeezing export-dependent Asia. If current high oil prices persist until the year-end, the region could suffer income loss of 1.2% of GDP. Moreover, if US imports from the region stop growing in 2H06, I estimate that the region could see its GDP growth rate cut by a further 1.2 percentage points directly.

• US Industrial Production up…but inventories rising and retail sales falling

The chart below from GaveKal Research shows the divergence between US retail sales and adjusted money growth—with rates climbing, we expect retail sales will follow the monetary base lower:

• Money supply “has declined from a 9% growth rate in December of 2001 to a miniscule 1.1% expansion in the twelve months ending June 2006,” writes Hoisington.

• Yield curve is inversion…2-10 year and “frontdoor” inversion with Federal funds above 10-year…“Over the prior 55 years, the Federal funds rate has exceeded the ten year note yield only eight times. Six of the inversions were followed by recessions,” according to Hoisington Investment Management Company.

Usually there is an 18-24 month lag before monetary policy bites. We are just over 24-months since the Fed began hiking the funds rate:

• Housing is under pressure. We are seeing prices fall in many formerly hot areas. Spec players are leaving their keys on the doorsteps for their bankers to collect later. A

The Housing Stock Index is looking very much like the Nasdaq did during its heyday and crash that began in Mar 2000…red line is the Nasaq from Apr 97 to Mar 01 overlaid on the current Philly Housing Stock Index chart:

Housing, we continue to be told is a key prop for the US consumer. In our neck of the woods—Florida—we are seeing real y-o-y price declines and rising foreclosures. The specs—by definition a highly levered crowd—are starting to run from the once very hot housing markets in Florida.

Metals and crude:

Maybe two different dynamics are involved in these markets. But in the end—once, or if geopolitics subsides—if global demand falls, one has to believe the demand for energy follows.

As for the metals, we have always believed this game is very much a liquidity-driven play at these levels. Initially we had the real catalyst—and still do to a degree—from China. But keep in mind, this investment game is played at the margin. Falling global demand and a slowdown in Chinese growth we believe will hit the metals hard.

Crude oil long-term weekly chart…(next page)

Jack Crooks, Black Swan Capital Black Swan Subscription-based Service


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Tue 17 July 2018
AA 08:30 GB- Employment
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AA 08:30 GB- Retail Sales
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