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Wednesday October 11, 2006 - 10:07:49 GMT
Black Swan Capital - www.blackswantrading.com

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It can change quickly

Key News
• The European Commission said the economy of the dozen euro nations is slowing more than it previously estimated and may even stagnate in the first three months of next year. (Bloomberg)
• The U.S. Federal Reserve is prepared to raise interest rates again if it appears that it hasn't done enough to curb inflation, Federal Reserve Bank of Dallas President Richard Fisher said Tuesday. (WSJ)
• Key Reports (WSJ):
7:00a.m. MBA Refinancing Index.. Previous: +17.5%.
2:00p.m. FOMC Minutes.

Quotable

"Run for your life from any man who tells you that money is evil. That sentence is the leper's bell of an approaching looter.”

Ayn Rand

FX Trading – It can change quickly


The bond market seems to be reflecting the change in expectations about the US economy from dire bearish on the housing background to modestly bullish on jobs and the consumer. It’s always surprise how quickly flawed future expectations can swing in markets. Which of course begs the question: Are modestly bullish US economic expectations flawed?


This recent view from Morgan Stanley’s Richard Berner, is a good one for cautious optimists on the US economy (a camp we find ourselves in):

[Our emphasis added]

In addition, the outcome of the housing-wealth consumer spending debate is still critical to the outlook. In that regard, we continue to think that the deceleration in home prices will be far less severe than feared. And we believe that the link between housing wealth and spending is only one-fifth or even one-tenth that envisioned by the pessimists.

In contrast with conventional views, however, we think that the list of positives for growth is beginning to grow stronger. First, we expect that a powerful surge in discretionary income will lift spending, courtesy in part of the recent plunge in energy quotes that is adding to consumer discretionary spending power. Pump prices don’t yet completely reflect the 75-cent/gallon slide in wholesale gasoline quotes, but with WTI quotes hovering at $60/bbl and crack spreads narrowing dramatically, there is room for further declines to about $2.25/gal. The gasoline price drop alone would give consumers up to $100 billion in discretionary wherewithal, compared with the August peak. And the slippage in natural gas and heating oil quotes could knock $20-30 billion from winter heating bills, even if winter weather returns to normal following last year’s unseasonably warm winter.

Equally, recent data give us even more confidence that the economy’s job and income generating capacity has improved. Job gains were tepid in September — payrolls rose by just 51,000 — but faulty seasonal adjustment issues may have artificially depressed government and private education payrolls. In addition, the August job tally was revised up by 66,000, bringing the average monthly job gain in the summer quarter to 121,000. That’s far from strong but enough to produce moderate gains in wage and salary income…While any upward revisions to job growth won’t by themselves affect official income estimates (statisticians update income estimates with a quarterly tally of wages that is close to the benchmark population count), faster-than-expected past payroll gains hint that any pickup in economic growth will concurrently boost jobs and thus pay.

Third, easier financial conditions are increasing financial wealth and enabling consumers to refinance debt on attractive terms. Since July, broad indexes of stock prices have risen by 6% or more. Over the same period, the 60 basis-point slide in bond yields, especially because it has been associated with a drop in term premiums, has also added to financial stimulus. Benchmark swap and credit spreads tightened roughly 10 bp over the same period. And there is no sign that lenders are tightening credit availability. Finally, still-healthy overseas demand seems likely to lift US exports. Solid gains in surveyed export orders and in capital goods bookings hint at improving demand both overseas and at home.

Berner’s view may be flawed, but we think it’s as solid as what we’ve seen based on the facts we choose to see.

The dollar is looking a bit “overbought” near-term. But overbought and oversold are nebulous terms chartists like to throw around. Looking at open interest levels on the CME suggests positioning is fairly light in the currencies—suggesting plenty more dollar buying power should the market come to the conclusion that a real trend is underway. Talk about potential flawed expectations—defining a trend is this market is a whole new bad of worms. For now, it appears the range is still alive, based on the daily chart of the $ Index below. But, never say never when human emotion is the key driver. It can all change very quickly.




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

 

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