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Tuesday December 12, 2006 - 15:00:13 GMT
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Do the pieces fit?

Key News
• German investor confidence recovered from a 13-year low in December. (Bloomberg)
• Britain's inflation rate rose to the highest in at least nine years in November. (Bloomberg)
• Key Reports (WSJ):
7:45a.m. ICSC-UBS Store Sales Index. For Dec 9. Previous: -2.6%.
8:30a.m. Redbook Retail Sales Index. For Dec 12. Previous: -1.8%.
8:30a.m. Oct Trade Deficit. Expected: $63.0B. Previous: $64.3B.
10:00a.m. 2Q Mfg Profits. Previous: 7.7%.
2:15p.m. FOMC meeting; interest rate decision.
5:00p.m. ABC/Wash Post Consumer Conf. For Dec 10. Previous: -1.


“There are several downside economic risks: The housing recession could deepen, capex is a question mark, and credit quality may begin to erode, triggering tighter lending standards. And weaker growth means more downside risks to corporate earnings. But upside economic risks and their consequences for markets should not be ignored: The housing downturn could end more quickly, the capital-spending pause may have been a false alarm, and although global growth may be slowing, US firms may be getting a bigger market share. For markets that have thrived on low volatility, these crosscurrents may begin to reverse that trend.”

Richard Berner, Morgan Stanley

FX Trading – Do the pieces fit?

The dollar supposedly fell yesterday on remarks from former Fed chairman Alan Greenspan. It is reported that Mr. G said we should see a “few years of dollar weakness.” If you’re a dollar bear, I’m not sure this is good news. Remember the Dow around 6,000 and Mr. G warned of irrational exuberance. And who can forget with short-term interest rates just beginning their climb, he told homebuyers to load up on Adjustable Rate Mortgages because rates were likely to stay low for a while. More proof that forecasting is a dangerous game, no matter how smart you are.

I remember someone saying once that when it comes to forecasting there are times when you have a right to forecast, but most of the time you don’t. It means that when all the pieces fit into place you should have above average confidence in your forecast and go for it. It’s similar to what Jimmy Rogers told Jack Schwager in Trading Wizards.

Jack Schwager: “What happens when you have one scenario for currencies, one for the stock market, one for the bond market, and not everything meshes?”

Jimmy Rogers: “Then I won’t do anything. It happens all the time. I don’t do anything until all the pieces fit.”

Are the pieces in place to forecast the bear market in the dollar is back in play and we will see a test of the all-time low in the buck in 2007?

I think we are getting mighty close. But until we see capitulation on the part of the Fed, which we haven’t yet seen, our confidence level in that view can’t be any more than average.

We think the Fed will capitulate, eventually. Because we see the risks to lower growth in the US greater than the chance this is an “average” mid-cycle slowdown. This is from Northern Trust yesterday and it makes a lot of sense [our emphasis]:

“The FOMC is expected to leave the federal funds rate unchanged at 5.25% on December 12. A preponderance of economic data -- sluggish payroll gains, a rise in the unemployment rate, year-over-year increases in initial jobless claims, a below 50.0 reading of the Purchasing Managers’ Index, declining construction outlays, declining auto sales, a deceleration in overall consumer spending and continued weakness in the housing market -- point to below-potential real economic growth. But before entertaining an interest rate cut, the FOMC will need additional evidence of a weakening labor market and a more evidence that core inflation has peaked. We expect that evidence to be at hand by the time of the March 21 FOMC meeting. By the time of the January 31 FOMC meeting, the Fed could give us a ‘heads up’ about an imminent rate cut.”

So we face another Fed rate decision where the rate decision part isn’t of that much interest, unless it is a surprise. But what is of interest is any hint the committee is seeing signs inflation is peaking (see chart below)—that might be the first hint of capitulation. That would also represent a key piece of the puzzle—it would fit.

Has inflation peaked?

Source: Northern Trust

Jack Crooks


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