Stocks, currencies fell, as markets anticipated Chinese rate rises

Events Friday appeared to be dominated by the release of Q3 Chinese GDP data, which came at 9.8, above the expectation of 9.4-9.6 current in the market. Inflation is reported to have eased to 4.6% in December, but that will provide no change to the government`s assessment of the current situation, and the need for rate increases, since price pressures in the commodity market, and the domestic sector leave very little room for any delay of the necessary action. We should recall that the government`s inflation target is just 3%, way below the 4.6% just mentioned.

The expectation of Chinese tightening has battered gold prices, which were lower to as much as $1345 per ounce during the last day of the week, as oil was similarly sold, losing around 2.65% off its value in Friday`s trading. We expect the difficulties in the commodity market to continue for the first half as the Chinese need to tighten is very real. In any case, prices of some commodities like silver and oil are probably already out-of-synch with their fundamental and technical trends, so a reversal of course will not be surprising. Still, we don`t expect the Chinese to be too aggressive with their tightening, and since the Fed will keep undermining the dollar, commodity trends will survive in the longer term, barring a major catastrophe such as a disorderly breakup of the Eurozone.

In separate developments, in a speech today Hu Jintao, the Chinese President, emphasized the necessity of "U.S. respecting Chinese sovereignty over Tibet and Taiwan", warning that acting in the opposite direction would create tensions in the Asia-Pacific region. He was rather frank in his words, saying that the history of bilateral relations shows the potential for steady growth if the countries respect each other`s points of sensitivity, concluding that "otherwise our relations will suffer constant trouble or even tension".

China`s concerns about about Tibet and Taiwan are well-known, of course. The Tibet issue  is probably the easier one, since, apart from the well-publicized protests of the Dalai Lama, and the occasional censure of various international bodies and U.S. Congress, there is not the remotest possibility that the Tibetans will be able to throw away the yoke imposed on them, or that the Chinese will face any significant security risks. India, which is the only  relevant  Asian backer of the Dalai Lama, has been trying to improve relations with the Chinese recently, and another conflict over the Aksai Chin or any Tibet-related issue seems extremely unlikely.

The Taiwan problem is an altogether different matter. We believe that the Chinese are make a mistake by playing their cards so openly, and leaving no room for doubt in their relations with the Americans. Arguably, this is born of their desire to maintain stability through an effective diplomatic deterrent, in that, if their partners and rivals are aware of what they will not be tolerating, the risk of a conflagration should be expected to be lessened. This approach makes sense from a Chinese point of view, since they see themselves as the righteous aggressors over the Taiwan issue, defending Chinese honor and power against the  humiliation of the past centuries. It also means that the Chinese do not expect the Americans to make a first move, such as inciting the Taiwanese to some declaration of independence, or an equivalent action that would force them to take action in terms defined by the U.S. It is unclear how much of a risk this poses for China over the longer term.

Apart from the propaganda value of such a stance, it is hard to see what strategic benefit the PRC gains from its current stance on the Taiwan issue. The U.S. can at any moment trigger a highly predictable Chinese response by encouraging the Taiwanese leadership to be more aggressive about the independence issue, potentially creating a crisis situation in which the Chinese have little opportunity to adapt to the emerging situation. The PRC leadership is, undoubtedly very well aware of this risk, and its very buildup of forces in the region, strong concentration of naval and air forces is probably directed at giving a clear sign of how powerful its response will be in case that a Taiwan crisis emerges. President Hu`s recent comments in the U.S. emphasizing this point, are to be understood in this context, and not a sign of belligerence or hostility, in our opinion.

On  the CNY issue in Washington, Democratic Representative Sander Levin of Michigan is reported to be planning to introduce a legislation as early as Monday next week, which will be reproducing the language of a similar bill passed by the House in September 2010. Hu`s response, while being questioned on it by senators, was that the problem is that "we, the China are more productive", and "have lower labor costs", according to Senator John McCain. Not very constructive, but one cannot expect Hu to say much else either. We are surprised that he was so candid with his answer.

In short, Friday was not a good day for stocks, commodities, or risky currencies, with the dollar, yen, and bonds generally being the better performers. We don`t expect this to change much in the near term, with the trigger point being signalled by Chinese rate rises, and their end marking the reinception of the previous bull trend. On U.S.-China relations, the main concern remains the currency issue, since, as both political parties are deeply out of touch with voters, it is but a matter of time that the politically lucrative, and low-cost USDCNY issue becomes too enticing a target for exploitation.  In the meantime, smiles will be maintained, since big business has as big a stake in seeing the status quo continue just as the Chinese leadership does, and with so much cash to spread around, it seems that the resolution can be delayed for quite a while.

Tunisia Seeks the Arrest of Former President; Questions About QE3 Remain in Trader's Minds

Tunisians are not satisfied with just toppling their corrupt and brutal dictator Zine El Abidine Ben Ali, but would like to recover him from his place of refuge, and subject him to a trial in which he can be questioned on his numerous crimes. It is possible that he will get the death penalty unless it is abolished by that time, although nowadays the death penalty is rarely executed.

Protests have been continuing in the Arab World today, with bloody confrontation between security forces and demonstrators in Egypt claiming some lives. Egypt`s benchmark stock index fell by 6.1%, bringing this year`s fall to some 12% already, CDS rates rose by 15 bps to 344, and 10-yr  bond yields rose by 7 bps to 5.89%. Investors are apparently alarmed by the turmoil, and no doubt the Israelis and the U.S. administration are even more distressed by the possibility of lasting instability in this turbulent and critical region.

Interestingly enough, Secretary of State Hillary Clinton was on the side of the Egyptian protestors with her comments today, calling for restraint from both sides, but emphasizing "that the Egyptian government has an important opportunity at this moment in time to implement political, economic and social reforms.”  This stance makes sense, since the remaining lifetime of the dictatorship in Egypt is probably limited by now even if it were to survive the recent clashes through some wonderous turn of luck, especially as the decade promises a lot of fluctuations in commodity and forex prices, creating a heavy burden on the already severely pressured Egyptian nation.

Among other things today, some are speculating on the possibility of another recession if the Fed stops its purchases in June, but that seems unlikely to us. We only need to recall that the current program was only launched because of unease in the markets and stagnation in the domestic economy. When the Fed Chairman announced the purchase program he made it clear that it was only in consequence of the commitment to "do whatever it takes" to prevent a depression that the central bank was engaging in  quantitative easing. He never hinted that the program would be final, or that he would be unwilling to supply more of the same if the economy failed to respond as it had been anticipated.

As long as Ben Bernanke remains in control at the Fed, we will have his clear commitment to keep printing unlimited amounts of money to depend on as we assess the future direction of the U.S. economy and the market. Since the Fed doesn`t depend on us, the Congress, the President, or anyone beyond itself in determining what to do with monetary policy, we have great clarity on which indicator we should be following while trying to decide if there will be a QE3 or not. This indicator is the Fed itself, its minutes, and statements, which alone have the power to decide whether there will be a further bout of easing. The Fed will almost certainly engage in another leg of quantitative easing in case it is found out by June that the economy will go into a deep plunge once stimulus is withdrawn. With much of the emerging market world growing at a much slower pace by then due to unavoidable interest rate rises, it is likely that the Fed will extend the term of its bond purchase program, even if it decides to wait a while before doing so. Perhaps the August-September period would supply the catalysts for such a course.

Elsewhere, the committee set up to investigate the causes of the subprime debacle has finished its 550+ page report and among its findings we will be reporting that shoddy mortgage lending, excessive securitization of loans and speculative gambling on such securities triggered the crisis, according to the New York Times. The report will assign part of the blame to Ben Bernanke and his predecessor Mr. Greenspan, while criticizing the Bush administration and Henry Paulson for adopting haphazard, ad-hoc solutions and failing to bail out Lehman. These conclusions are generally agreed to by the market, and we only disagree that a Lehman Bailout would have made much of a difference. The whole financial system was burdened with worthless mortgage paper, and counterparty risk, and if it were not Lehman, the nerves of the public and the administration would have snapped at some other firm. With hindsight, it does appear that a takeover similar in strategy to the Bear Sterns deal could have been adopted delaying the breakdown of the system in September 2008, but this would never have satisfied the short-sellers, or the bears in the market, since, as we noted, the whole system was infected with the disease, and a collapse was almost inevitable. Further, while we may have ideal scenarios in our minds about government officials acting like corporate bosses, it is not sensible to ignore the fact that their responsibility is not only towards the economy, but also to the people at large. A degree of subservience to popular will is inevitable in a democratic system, even though this sometimes leads to difficult and painful results. This analysis doesn`t consider the viewpoint that bailouts are morally and fundamentally wrong, since the case for this position has been made many times by others, and there is no need to repeat it here once more.

With respect to the Obama Administration`s deficit reduction plan, our opinion is that unless similar restraint is shown by the Federal Reserve it is like plugging one hole in the ship while it keeps leaking from three others. The impact on the USD, gold, and the economy is dependent, to a large extent, on the Fed`s choices, since, as it is widely acknowledged by markets, the monetary policy of the United States is determined by the FMOC. This is different from the situation in China where the PBOC is not at all independent, or Japan, or the UK, where the central bank is expected to coordinate its actions with those of the government, even as it retains a great degree of independence. The President`s plan makes sense in many ways, but before we can speak of a real reversal in the fortunes of the dollar, or the gold market, we have to first see the Federal Reserve restrained, and brought under closer supervision so that its chain of exotic experiments is brought to an end.  

ElBaradei Returns to Egypt; S&P Downgrades Japan

Protests in the Arab World continue, and with every passing day, the power grip of the dictators seems weaker, with strong implication for regional geopolitics and the global economy . Today`s main event in the finance world is the downgrade of Japan`s credit rating by S&P.

After nine years of lull, S&P has downgraded Japan to AA-, with a negative outlook, on the grounds that the Japanese government doesn`t have a coherent plan to manage the high risk posed by the mountain of debt that Japan has accumulated over the past 20 years while trying to pursue a similar strategy to that recently espoused by Ben Bernanke in the U.S. Enormous sums have been spent in order to restart the Japanese economy through public spending, but it has not been enough to reverse the mood of the Japanese public, and they have become as pessimistic nowadays as they were optimistic in the years before 1990, when the economy was charging ahead. 

We, like many others, are of the opinion that the  Japanese have their heads in the sand and don`t know what they are doing. Apart from the complete lack of credible political leadership in the country to address immediate issues such as those that exist between Japan and China, or the necessary economic reforms that could help rebalance the bankrupt domestic version of the Asian model, Japan is also clueless with respect to the long-term challenges that it faces over the next decades. A meaningful rise in interest rates would quickly constrain the hands of the Japanese government, leading to  unpredictable results for the country, and of course for the world.

Still, we don`t expect to see the Japanese trigger an Asia wide crisis, although we do not completely disregard the possibility of such a development. The Japanese economy has been running on external dynamics for a long time now, and no one follows trends in the country as a potential indicator for regional or worldwide events. Japan has been living with a liqudity trap, with a stagnant domestic market, and deflation for a long time, but nobody is too worried about any of these otherwise menacing details while purchasing Japanese debt. S&P downgrade is significant in that sense, but as long as the rest of the world is able to recycle JPY to some higher yielding asset somewhere, create growth, and thereby, demand for Japanese products, we believe that the Japanese economy will keep teetering on the edge, threatening to, but never actually collapsing for some time. 

In short, Japan`s performance is tied to factors that are outside of the country`s control, and the most important variable in this context is China. While it is often thought that Chinese competition is detrimental to Japanese performance, any handicap to Japan caused by China`s competitiveness is easily compensated for by the global dynamism that is brought about by Chinese consumption, trade, and investment.  The Japanese know this better than we do, and that is why, arguably, they are always dovish on any confrontation with the Chinese communists, apart from any moral and historical reasons that they may have.

In other events, we were surprised to see in an article on Bloomberg today that our pessimistic opinion on China is not as isolated as it would seem on the basis of the frequency of opinions and articles with a similar bent on news sources. 82% of participants in a global poll organized by the financial news provider have indicated that they expect a financial crisis in China after 2016, with about 42% expecting the crisis to hit within the next five years. Only 7% were so audacious and bullish on the country to say that such a thing would never happen. 53% of global respondents regard the Chinese economy as a bubble, and the concern is even higher among the country`s Asian partners where the proposition that China is a bubble finds approval by 60% of respondents. By contrast very few investors seem to expect a political crisis in the country, with only 27% expecting such an event in the next 2-5 years. We think that this risk is being underestimated, as frustration with the CCP is only hidden by economic strength if the country, and it is but a matter of time before disapproving voices are raised, if the feel-good sentiment of the moment is lost.

Today stocks are weaker, gold and oil are lower, while the USD doesn`t seem to benefit a lot from this situation. We`ll keep you updated with Chinese and Asian issues, as we expect the region to generate the most exciting news for the coming decade.

Demonstrations in Egypt Continue in Spite of Curfews; Markets Sentiment Tense

Tens of thousands of people have been demonstrating all over Egypt over the weekend, with Suez, Alexandria, and Cairo, the biggest cities of the country experiencing heavy protests and and some clashes between the people and president Mubarak`s security forces. There was a nation-wide curfew in effect throughout the country on Saturday and Sunday, but this was disregarded generally. In Cairo, the regime`s police appears to have evaporated completely, while army forces that have replaced them have stayed content with silent observation and prevention of looting by outlaw elements. The regime has tried to intimidate its own people with heavy-handed methods, flying jets over protesting masses in Cairo`s main square, sending helicopters to fly low and harrass the people, and at one point many commentators were speaking about an ominous atmosphere, hinting that some kind of bloody confrontation could be imminent.

That did not come to pass, and we don`t expect the regime to survive. Even the most popular and successful kind of government would generate a lot of resentment after 30 years of continuous, autocratic rule, and the Mubarak regime is anything but popular or successful. What has kept it alive over so many years is American aid, state terror, and a strong oligarchic network of patronage which is a common feature of the autocracies all over the Middle East. Now that U.S.  support is not as strong as it used to be, the regime has only brute force to depend on, but economic difficulties faced by the people blunt the effect of violence.

The man in focus in Egypt is Muhammad ElBaradei, who seems to have succeeded in unifying the fragmented opposition in the country behind himself by brokering an alliance with the influential Muslim Brotherhood on Sunday.  This group has suffered the worst aspects of the regime over many years, and many of their jailed leaders are reported to have escaped from prisons around the country as officials are busy trying to control the streets. By throwing its lot with the highly-respected ElBaradei, the group is taking a pragmatic stance, recognizing that the toppling of the regime is its foremost goal, and that the other issues will only become issues if the country is rid of the dictator.

The regime has lost a lot of prestige by its inability to enforce its will on demostrators, and it is possible that a point of no-return has been passed by the protests entering their sixth day against the clear opposition of the government. Demostrations have been bloody, with more than a hundred of people killed, but at the same time it is clear that the army has maintained a great degree of self-restraint, leaving the dirty work, so to speak, to the regimes secret police, and special security forces. This one peculiar fact has been the main reason of the demonstrations` success so far, since it is probable that if the army had been moved to stage a brutal crackdown, of the kind effected by Hafiz Assad in the 80s, or Saddam Hussein during his years of his rule, even the most ardent revolutionary would have to give in and scramble for his life. Flesh doesn`t cut steel.

We believe that the Middle East, and the world are entering a new, and dangerous stage with the collapse of the established order in the Arab World. Egypt is a huge country with 79 million people, a GDP of $500 billion on a PPP basis, and has played an important role in setting the direction of the region since the breakup of the Ottoman Empire in art, culture, and science with the Arab world`s only four Nobel Prizes going to Egyptians. The Egyptian Ahmed Zewail is the only winner of a Nobel prize for scientific work in the entire region. In short, what happens here will set the trend in the Arab World, and by the familiar domino effect, in the world of finance and economics.  

In response to all these, short-term borrowing costs for emerging market debt are rising at the fastest pace since 2008. The Egyptian banks and its stock market are closed. Global markets have shown a mixed performance so far, and the Euro is also doing well as it perhaps seems like a safer haven in all this turmoil. Gold has been falling, predictably, as expectations of rising inflation and risk compel speculators to expect higher interest rates, and lower demand for gold around the world. We expect gold to keep falling, but at the same time, we remain confident that the longer term uptrend will remain in place as long as developed world rates are low.

U.S. Urges China to Appreciate the Currency; Bernanke Expects 3% Growth for 2011

Gold stabilized by the end of last week and is appreciating a little, but the main theme of the market remains the indecision that we typically observe in this part of the year. For the past few years, markets have been tending to rally towards the year end, and sometimes this momentum reverses in the ensuing period. This year seems to follow a similar pattern. As such, we believe that gold will remain at around the level that it presently is, barring a sharp appreciation of global equity prices.

Meawnwhile, just a week before the Chinese President`s crucial visit to Washington, Gary Locke, the Commerce Secretary of the U.S. was reported as speaking of a turning point in the U.S.-China relationship. “Last year, China became the second largest economy in the world. And the policies and practices that have shaped our relations over the past few decades will not suffice”, he is reported as saying. This comes, of course, after yesterday`s comments by Tim Geithner that China must strengthen its currency. Other issues that relate to trademark and copyright theft, Korea, and and the trade surplus,  will be some of the top issues in the presidential meeting this week.

Should we expect the Chinese to submit to American pressure? Our pessimism about any substantial improvement in the bilateral situation is well-known to our readers, but with inflation running so high at home, the Chinese will be more amenable to somewhat faster appreciation of the currency, and the announcement of such an agreement could be regarded as a kind of public relations achievement for the Chinese too. In other words, we suspect that if nothing significant would come out of the meeting, the likelihood is that not mch should be expected to happen for the first half  of this year on the USDCNY issue. All these imply that this week`s Chinese visit will be a very important event for us to watch.

The reason for our pessimism is that the Chinese system is not the kind that the Americans are used to working with. The country is huge, with ubiquitous corruption and a highly immature, and complicated legal system greatly hardening the task of those who would like to see strong improvements in a short time. The same is the case with the Chinese, who, for example, threatened to degrade relations with Norway in response to the Nobel Prize awarded to the dissident Liu Xiaobo. Neither side understands the other very well, both are highly suspicious of their partners behind the smiles, and have a tendency to usually expect the first step from the opponent before making any moves themselves.

In other events, the Fed Chairman is preventing is interpretation of the recent rise in interest rates as a sign that the economy is doing better. He says that it is not an indication that the Fed`s bond buying program is failing. But isnt`t there a chance that it is both? Still, we would like to give him the benefit of the doubt and perhaps attribute the rate rise to the recent improvement in outlook, which is, one should grant, not at all insignificant. This doesn`t mean that the economy is doing any better, but it means that the market buys the idea that the Fed is capable of inflating asset prices by pumping money. Higher asset prices implies an illusion of higher net worth for individuals, which should bring higher consumption, and a stronger growth outlook. It is not clear, nonetheless, that the recent boost to the outlook will be last as long as some people seem to believe.

He expect a growth rate of 3-4% for 2011, and along with his team at the Fed, he is looking at ways to improve the flow of credit to smaller companies. The funny thing is that he is the one responsible for the reduction in credit volumes to smaller, innovative companies. If you were the loan officer, would you extend credit to the government backed behemoth, or the promising upstart from somewhere with only an innovative, but untested to back his claims and pledges. The answer is obvious. It is not for no reason that the Soviet Union stagnated and collapsed in the 80s, in spite of its great advances in technology, science, and international prestige and power. The cycle must move on, and in our universe, destruction is a necessary part of the creative process. Perhaps there was a way out of the 2007-2008 that could have averted the worst results of the crisis, but apparently the one that the Fed and the Bush adminsitration chose, in which all the failing firms were saved in the name of too "big to fail", was not the best possible decision.

These debates, of course, will go on. All that we know is that the buildup of imbalances will not go on forever, and further, that the longer the cycle of bubbles lasts, the more times it is restarted, the more destructive it will be when the edifice of cards finally comes down.

 

U.S. Markets Find Some Strength on EM Interest Rate Rises, Fitch Cuts Greece

U.S. markets are happy, somehow, that emerging markets tightening to combat the effects of U.S. Fed imposed money inflows and consequent inflation will improve the appeal of domestic stock markets, and maintain the current momentum to higher levels. It is, to say the least, a very strange point of view. We wonder if it wasnt the Fed`s promise to pump money into the bond market that lifted the equity markets out of their depressive mood, and fuelled the global rally that has been going on since September. Up until Mr. Bernanke`s clarification that he would do whatever it takes to float the economy, a recession was being anticipated. The strong performance of emerging markets, the appreciation of their currencies, and the improvement in their consumption trends that ensued, was clearly the major if not the main driver of the turnaround. And now, we`re elated that emerging market demand will contract in consequence of rate rises? Where is the sense in that, and on what kind of basis do people generate such analyses?

On no basis, naturally, since markets are driven by impulses, not commonsense. Not that commonsense would have benefited us any way, since, even that doesn`t seem to be enough to help us in the face all the strange contradictions that are popping up around the world. But as human beings, we tend to believe that being reasonable is an advantage.

A very interesting piece of news came from the North African Nation of Tunisia this year where the President in power for the past 23 years, Zine ElAbidine ben Ali has quit his office, and and finally was forced to  flee the country after massive protests proved to be too much for his regime. Dismayed by high unemployment and a very corrupt administration, Tunisians have ousted their dictator from power. It is a good sign for the world at large that another dictator has been forced to say farewell to his palaces, police, and powers, but from a more general vantage point, it is not really that clear that the recent events will prove to be constructive for the trends that the optimists expect. The loss of economic stability has damaged social accord and political harmony in many nations around the world, and as the global society transitions from its present state of disequilibrium to a new mode of existence, events of strong impact must be anticipated.

In Europe, Fitch has cut Greece`s long-term debt rating to BB+, which is a junk level , and maintained the negative outlook in place for the country. Moody’s lowered its ranking for  Greece to Ba1 on June 14 and S&P rated the country at BB+ from BBB+ on April 27. The Euro wasn`t impacted by the news, and is in fact somewhat higher on the day. Since stock markets around the world have been performing reasonably well, it seems that the currency has been supported by the general optimistic mood, apart from anything specific.

Euro Lower as U.S. Prepared for the Chinese President's Visit

The Euro is lower once again yesterday, as concern rises that the region will be unable to form a united front against the approaching wave of refinancing in the European sovereign debt market, even as the finance ministers meet in Brussels to discuss what can be done on the issue of bailouts. The stock markets were mixed, gold was mostly unchanged. Not much attention appears to given to comments by Fed Chief Charles Plosser, who would once again not rule the possibility that the Fed may raise rates even if economic growth fauls to improve significantly, and unemployment remains high. 

On the other side of the Atlantic, Hu Jintao was repeating, in written comments to the WSJ, that yuan-appreciation will not necessarily help resolve the trade balance issues, nor tame inflation at home, essentially refusing every argument that the Americans had been advancing in the months leading to the recent meeting. Continuing the complacent tone typical of Chinese authorities, he said that the recent rises in inflation are mostly manageable and moderate, adding that rising prices can "hardly be the main factor determining exchange rate policy". The Chinese president emphasized that the internationalization of the yuan will be a "fairly long process", adding that the dollar`s primacy as a reserve currency is a "product of the past". He is going to meet President Obama this week, so these comments do not seem to be very encouraging for those who would expect major breakthroughs to be reached in the meeting. To us, they seem as frank and strongly-worded as you would get from a Chinese official of his rank.

Meanwhile, some are questioning whether the strategically significant Arab world may see major dislocations in the coming months and years as the dictatorships and unpopular regimes that dominate the region at the moment face great popular discontent in the aftermath of the global economic downturn. This region has always been a focus of interest for upheavals of great magnitude, but it is only now that the populace finds itself in the position to risk everything against the power of batons, tanks, and bullets and to voice its discontent with despotism in unmistakable terms. For many years, it was thought that the rule of despots and dictators would be unassailable for the foreseeable future, and the term "Arab Street" had acquired the character of a joke in many circles, as the long-anticipated revolution of the people failed to materialize in every possible scenario including great turmoil in Israel, and the Iraq War. Many reasons exist for this, but perhaps the most important one among them was the long-lasting economic stability of the world that ensued the disintegration of the Soviet Union. Dictatorships that had been established towards the close of the Cold War benefited from the brutal tactics inherited from those times in their struggle for survival against their own peoples. And the lack of a severe economic crisis disarmed the people, who were mostly content with going on with everyday business, satisfied with cursing the leader occasionally, but too absorbed in material necessities and  survival to stage a challenge to the despot. That seems to be over now, with the events in Tunisia starting a trend which, we believe, will see many more regimes crumble this decade.

The importance of this matter for global trends cannot be overemphasized. The region is home to the Suez Canal, huge reserves of oil, large stockpiles of conventional weaponry, and is defined by a political structure that has almost no meaning in terms of the relationships between the nations and cultures populating the region. There is, for instance, a lot more in common between an Egyptian, Syrian, Iraqi or Libyan than there is between a German and a Pole, and Italian, and a Swiss national. These nations are now united under the umbrella of the E.U. (with the exception of the Swiss), but the Arabs are living divided into sultanates, despotates and apanages the existence of which can only be justified on the basis of personal gain, corruption, and nepotism. This will not continue for long, probably, and who knows what this means for this rich region home to some 200 million people?

Bloomberg reports that Tunisia is in fact one of the more successful dictatorships in the Arab World, with regimes in Libya, Algeria, and Egypt ranking well-below the country in global measurements of corruption.   Tunisia had unemployment of about 13 percent, which is not at all extraordinary in this part of the world. Even the more advanced Turkey on the other side of the Mediterranean has been suffering from double-digit unemployment rates for many years.  Since nobody, including ourselves had been expecting a revolution in this country recently, it is but a matter of speculation to say who will be the next one to fall on the long list of candidates among Arab regimes.

We believe that these developments are being watched with concern by Israelis and the Americans, while the Iranians must feel some relief that the circle of pro-U.S. regimes surrounding them is slowly crumbling. It is a matter of time, to be sure, and we`ll do our best to update you as events in this important part of the world progress into the next year.

Hu Visits U.S., Markets Enthusiastic on Europeans Packages, Commodities

Today stocks are higher almost everywhere, with British, and European companies being the best performers of the day.  Among currencies, we find the USD depreciating against most except the JPY, while gold has appreciated significantly from the recent lows of $1360 recorded a few days ago. Oil continues to hold on to the $91 per barrel handle.

Some news about Chinese platinum purchases, and silver stocks dwindling in Europe according to the blog "Zerohedge" are making the news. We believe that these factors have only a small role in determining general price trends, but it is true that, with respect to individual commodities, significant shortages may turn out to be the main drivers of price trends. At the same time, it is not wise to have too much faith in the rumor mill, as refutations of the same shortage can be found in the news media too. Over the long term, in any case, the trend in the commodities market will remain pointed to the upside for as long as the USD weakness continues.

Today`s most important event is the visit of Chinese President Hu Jintao to Washington, where he will meet U.S. business leaders, tour Chinese factories, and have a private dinner with President Obama and his main aides at the White House. The main theme of the visit is economic relations, with both sides willing to deemphasize some of the salient points of disagreement. Americans would like to export more goods to China, which is only possible if a modest amount of goodwill and cooperation is maintained between the two sides during such events. Any unexpected disagreement will not only be bad for bilateral relations, but it will also dynamite the U.S. administration`s stated plan to transform the U.S. to a more balanced growth model. We believe that the Chinese are in the U.S. in order to hug and kiss like pandas showing their softer and enchanting sides to their American partners, with the hope that the status quo can be maintained forever. We doubt that they have any intention of addressing the root causes of the recent difficulties in the relationship, but we would expect to see at least some kind of announcement to satisfy the Congress and opinion-makers in the U.S. so that serious, longer term commitments may be avoided. This is China`s, and in fact, Asia`s main strategy. Delay the inevitable for as long as possible. Keep hoarding cash, promise improvements, and do as little as possible convincing yourself that everything is fine. But even a very elementary analysis of the situation would show in the clearest terms that in fact this approach is creating enormous dangers for the region and for the world in as much as it is based on bubbles, and contradictions that will inevitably collapse at one point regardless of the convictions of Asian leaders.

Bilateral trade between the two countries has reached a volume of more than $400 billion recently, unhindered by the President`s, Treasury`s, and the Fed`s insistence that the Chinese must do something to reduce their surplus. The surplus has been rising, and will probably come down this year, if at all, only because of the measures that the Chinese will have to adopt in order to manage their inflation problem.

Trade agreements are beign signed, and smiles on both sides outshine the gloomy aspects of the bilateral relationship for now. We`ll return to this subject tomorrow as the Chinese President`s visit, the first since Jiang Zemin`s visit in 1997, continues.

Apart from meeting the Chinese leader, the U.S. president is also busy working on reforming business regulations in the country in order to make businesses more competitive, and the labor market more flexible. In an article in the Wall Street Journal, he voices his commitment to balancing the needs of business with the needs of the consumer. Still, we think that the trend in the next few years will be towards tightening or maintaining of regulatory standards, since the laissez-faire approach of the past decades seems to be almost complete out of vogue with politicians and voters in the world at large. That doesn`t mean that some cosmetic adjustments can`t be made here and there, and perhaps certain sectors, like technology will indeed benefit from the changes, but on the whole, we believe that regulators will have a tighter control over economic life in the coming years.

We conclude by taking note of the fact that there continues to be some concern about the recent rise in the spreads of longer to shorter term maturities in the Treasury market, with some warning about a possible beginning of the end for the U.S. government as its obligations challenge its refinancing capability in the of face rising interest rates. Is this likely? Probably not in the short term, since, as Ben Bernanke recently explained, the recent movements are probably being caused by expectations of better economic performace over the year as much as they are caused by worries about the government`s ability to make repayments. The U.S. is unlikely to face the kind of challenge that some would expect to see unless a kind of severe domestic political issue or geopolitical crisis overtakes the headlines sometime in the near future. The European problems are enough to justify an elevated level for the USD price at least against the Euro, which means, in our opinion, that the U.S. unit will see stable, but not great demand for this year and probably the next,depreciating  gradually in line with the government`s expectations.

 

Outlook for 2011 and Highlights From Last Year

2010 had a mixed tally. Risk markets performed well in general, but much of it was due to the past, present, and future effects of actual and anticipated easing, rather than a concrete set of data that can be said to show a fundamental improvement in the shaken financial system. 2011 will probably continue on similar notes, with QE expectations, Eurozone troubles, and China`s economic performance being the main themes if no black swan event hits the market. Of that we have plenty in stock, and only provide a small, yet choice selection in this brief overview of what could drive trends in 2011, as seen at the beginning of the year.

Tensions in the Korean Peninsula: The world has forgotten about the North Koreans and their bombs. For the past few days parties and celebrations were in everyone`s minds, and the mutterings of the eccentric autocracy far away in East Asia were wished away without much thought. But the problem is real, and won`t go away by just being ignored.

North Korea is the joker in the game, since no one knows where it will pop up, and what it will do when it does. There is no guarantee that the Korean Communists will not declare an all-out war against their alienated brothers to the south, and no guarantee that they will do so either. We are simply held hostage at their whim, and can do no more than hope that they act like rational beings.

But if we expect rational beings to escalate crises in stages, as a sign of anger and frustaration, the North Koreans have been doing precisely that. They have successively intensified the tone of their actions, and as we all know, recently went so far as to bomb an inhabited South Korean island. They seem utterly unwilling to bow to pressure and will not be satisfied unless some of their specific demands are met. The U.S., on the other hand, is reward NKorea very much for its extravagant   actions.

We believe that 2011 will see more serious escalations of this crisis, provided that the U.S. does not bow to the pressure and accept some of the North`s demands. A war here would probably send the dollar and gold higher by more than 10% in short order in 2011.

European Sovereign Debt Crisis: The Eurozone crisis is clearly the main item on news reports when we speak about risk and downturn. At the same time, however, positions have already been taken on this issue, and it will take a real surprise to suddenly shift perceptions on where the Euro and the common market are headed. That said, the Euro`s fate will probably keep providing most of the headlines this year as it did in 2010, since the stakes are high, the potential for loss is great, and the authorities will not be give up easily.

There seems to be two conflicting viewpoints in the Eurozone leadership as to what should be done about the crisis. We are made to believe that the Germans, and their followers want to be stern and strict with the delinquents, while the nations at risk of default naturally want to be treated as gently and leniently as possible. While it is conceivable that such a division of intentions and desires of the two parties exists, the distinction rapidly breaks down in the face of reality, since, faced with the caprice and whim of the markets, both sides are very well aware that the stakes are too high to be too nitpicky about a couple of hundred billion Euros here and there. With almost Eur 900billion  already committed in one way or another to the bailouts in order to keep the union intact, we find it extremely hard to believe that Germans can say no, but of course they will be protesting and making faces right up to the foot of the wedding bed.

We do not envision a European default in 2011. Barring a repeat of the events of 2007-2008, we believe that the troubled nations will be bailed out, with the real costs of this only materializing after the next elections in the European nations. A very fragmented picture will then arise, making the attainment of the traditional European consensus an intractable matter. The Euro will probably be the victim of the ensuing conflicts and quarrels.

U.S. Home Prices: The U.S. economy is the largest in the world, and for us, the single most important variable that will determine whether it can lift itself out of  its Japanese malaise is the home price trend. Homes are a household`s most valuable possessions typically, and they  compensate for the lack of savings when prices are appreciating. Home price appreciation, in other words, serves like a proxy savings mechanism masking the fact that the consumer barely sets aside any money for rainy days, since, if the worst were to occur, he/she can just sell the home and move to a more modest environment, meeting the necessary expenses with the difference. As we all know, homes also used to serve as immobile cash machines in the blushing days  of the home price bubble, but we don`t think anyone is entertaining the possibility that those days will return any time soon. 

Given the heavy weighting of the house in the family`s net worth, we believe that nowadays there is a strong relationship  between a family`s sense of financial well-being, and the value of its dwelling.  That implies a strong reflection on consumption trends overall. And if we add to that the obvious psychological impact of forced home sales and crowds of homeless wandering around, price trends must be expected to have a relationship with one`s appreciation of the economy`s performance, and the outlook in general.

What happens to home prices in 2011, then, will remain a crucial indicator of economic performance. We believe that there won`t be any tangible improvement, or trend change for this entire decade, barring runaway inflation.

China`s Interest Rate Policy, and EMs: Our opinion is that China remains the most important part of the puzzle on the future of interest rates, currencies, and gold prices, and speculative trends in general. Apart from the well-publicized fact that it is the fastest growing nation in the world nowadays, the Chinese are involved in almost every single speculative game in the world, be it the U.S. Treasury market, FX trends, commodity  (including gold and oil of course), or stock prices. Money that originates from, or because of China, pumps up all these markets, as we have discussed in these pages many times before, and if the Chinese factor is removed it is clear that there is nothing of equal size or significance to let the speculators speak about decoupling, shifts in focus and paradigms, strategic rebalancing, and the many other forms of the same circular argument.

The Chinese will surely be raising their interest rates multiple times this year. That much is a given, since not doing so would risk placing the country in the miserable state of the helpless Vietnam just to the south. But whether they can stop the Chinese people from creating inflation through policy change is harder to say. On the one hand, we know that the Chinese consumer is very different from the American consumer, and will be easily cowed to increase savings and tighten spending at a slight sign of uncertainty about the future, especially if it is being communicated by the (almost) all-powerful CCP. On the other hand, the Chinese consumer is swimming in cash, has the highest savings rate in the world, and has been exploited to no end by Chinese entrepreneurs who have been working them at third-world wages even after the country has long lifted itself out of third world status.

Chinese interest rate policy, its duration, and the magnitude of cuts, then, will be the most important event of the year, and furthermore, since it is certain to happen, it will be the keystone of all analytical directions for 2011. Our outlook is that China will slow down this year, partly because of the government`s rate cuts, and while we are certain that the country will at one point suffer an economic collapse, we are skeptical that 2011 will be that point. The CCP is only too easily cowed to ease, and if there is any sign that the economy is getting weaker, we believe that they will be only happy to lower rates once again (or they could just tweak the yuan, ignoring the screams of dismay from Washington).

Federal Reserve and QE-X: The Federal Reserve can never be too far from our minds, as we probably owe the stock market rally, and the improvements in risk sentiment to its declared intention to do all it takes to keep inflation from turning to deflation. The Fed is watching corporate credit interest rates, mortgage rates, industrial output, and the output gap, as well as the inflation expectations of the population, and sees, apparently, only the slightest signs that matters may turn better in the near future. With inflation staying surprisingly low throughout the robust performance of the markets, and even of the economy at large, the central bank sees no reason to reduce the pace of monetary accommodation, and as we know, is instead planning to flood the global markets with ever increasing amounts of dollars in order to boost risk sentiment, and force people to shop.

For 2011, whether the Fed will announce a third round of quantitative easing once the present program ends will be the main topic of discussion. While we recognize that the U.S. economy may look better at the end of the first phase, we believe strongly that QE2 will not be the final one, and the Federal Reserve will keep pumping more money into the system in Japanese style, until the bond market rebels, or world trade collapses, depriving the government of its major buyers of debt in Asia. For now, though, Mr. Bernanke`s public, and legitimate Ponzi Scheme continues.  It will end when there are no more buyers to recycle cheap dollars to.

Protectionist Pressures: Trends in global trade, output, and politics do not change rapidly. Fluctuations happen all the time, but it takes some time, and considerable incentive before people will  permanently reconsider the ways and means of the past, and readjust their outlook in accordance. Protectionist pressures in response to the rising unemployment rates around the developed world likewise take some time to build up, but from our point of view, there is little doubt that eventually, in three or four years time, the world of trade and finance will be very different from what it is today. And we are not talking about cosmetics, fine-tuning, or temporary adjustments that allow business as usual. Protectionism as the antithesis of liberalism, will force a major change in the way business is conducted around the world.

Arguably, the most significant steps towards protectionism will not be taken under the Obama administration, which, for all its talk of change, has in fact changed a miniscule amount of details from the common practice of the Bush years and before. Barack Obama has surrounded himself, especially in the economics field, with distinguished, yet orthodox names like Larry Summers (although he has left recently), and Tim Geithner, who are very unlikely to deliver the kind of change that the American public wants. That is not to say that Mr. Geithner or Larry Summers are wrong on all, or even most of their opinions, but the policies advanced by them do not deliver the kind of drastic change that the electorate wants, and in the absence of that change, utterly fail to provide the kind of populistic accommodation that would soothe the desire.

In sum, as Barack Obama`s term completes its first half, the risk of a backlash keeps increasing, as change fails to materialize. This year we might see, at most, a couple of complaints being launched at the WTO against the Chinese, and more verbal pressure applied on the nation`s leaders. But that  will be the limit, and it would be enough to save the President from the wrath of the voters as they turn to vote for the most sensible populist they can find on the ballot list.

Rare Earth Materials Shortages: There are many points of contention between China and the democratic nations of the world. China has land and sea border problems with India, Japan, Vietnam, and Malaysia, Philippines, and others. The country has fought wars with Vietnam, the Soviet Union, and India over the past forty years. Nowadays, however, the most likely avenue for the release of escalating tensions is the WTO with trade issues providing the cheapest and easiest opportunities for China bashing.

Needless to say, the Chinese have been provoking their adversaries to do just the same, with the plans to cut back on rare earth materials production being interpreted as a clever ploy to boost domestic producers of high-tech equipments through anti-competitive quotas imposed on the rest of the world. As the country produces about 90% of the world`s total output in this sector, it does have the leverage to impose prices and corner the market, as well as isolate and eliminate competition through selective supplying of raw materials. Since China is in no position to provide outright subsidies to Chinese companies due to fears of disastrous retaliation, imposition of quotas on rare earths creates a good alternative method to boost the nascent domestic high-tech sector. The only problem is that, while reaction has been slow, China`s partners are not buying this game, and it will be very interesting to see how the response to Chinese policies develops around the world, as 2011 progresses.

Israel and Iran: This issue has not really left the center stage of events at any point, but with the alleged Stuxnet operation of the Israeli secret service that delayed Iran`s capability to produce enriched Uranium considerably, the stakes seem to be higher. The Iranians have no intention of stopping their fuel enrichment programs, as this is seen as a matter of national pride and prestige, while the concerns of the Western World are focused on the enrichment issue alone. In consequence, a quick solution to the problem seems highly unlikely this year, raising the bar for an eventual military conflict that could send the FX and commodity markets upside down, and open the door to an enormous degree of volatility. It is safe to assume that the Americans will do everything in their power in order to prevent a military conflict in the region, and the most likely outcome would be their success in controlling the Israelis while intensifying the pressure on the Iranians through international channels. But the risk that events will procede in an unpredictable and dangerously chaotic fashion cannot be disregarded fully.

Markets Open the Year on a Note of Optimism, Stocks Rise Around the World

On the first trading day of 2011, markets were showing an optimistic performance, with stocks around the world ending the day higher, the dollar gaining against most of its peers, while gold rises once again above the 1410 level. Gold has been testing these levels for almost two months now, and a breakout to either direction should easily bring sustained momentum. We cannot disregard the possibility of a solid correction if the Chinese authorities signal too much pessimism about the performance of the economy, or if the Eurozone sovereign debt worries return without finding a decisive commitment from the Germans. But on the whole, the trends are being determined by the Federal Reserve and its anticipated bond purchases, which creates optimism about the global economy, boosts commodities, and of course gold too, which has its own additional reasons. For as long as the current mild atmosphere continues, we think that the present state of affairs in the markets will be maintained, and gold will continue to appreciate.

On Friday we will have the NFP release, so market focus will be on the numbers, but this piece of data is clearly not as dominant or powerful in the minds of traders as it used to be for much of the past decade. Instead, what everyone seems to be focusing on is clearly the Fed`s stance, partly because it is understood that the private sector is not in a position to create the necessary momentum in the jobs market, and partly because stock prices are nowadays driven almost entirely by inflation and risk expectations. That is not to say that growth will not pick up as well, but there is a difference between building a car factory for the middle class and building an empty city of skyscrapers in the middle of an empty desert (of which the greatest experts live in China). Both are recorded as growth, but whether they are the same kind of growth is a matter of debate. As such, NFP does not have the kind of relevance that it had when everyone believed that data and economic activity drive stock prices. The Fed is easing, and easing is good for U.S. stocks, so they appreciate.

In any case, the U.S. is performing better, having been smashed earlier in the crisis on the implosion of the real estate bubble, and the cleanup process is naturally less painful than the contraction that precedes it. Reflecting this, Bloomberg reports that investors are demanding a smaller premium to own U.S. corporate bonds than global company debt at 166 bps vs. 169 bps. for the latter. We think that this trend will continue for another reason apart from the better U.S. outlook. We believe that in the coming years home bias among speculators will increase, as the international political environment becomes difficult and cloudy, protectionism becomes the new fashion, and capital controls are introduced or tightened around the world. This is only a natural, corrective reaction to the liberalism of 1990-2008, and it probably does not signify a permanent reversal, but clearly, from a speculative point of view, it does imply that U.S. stocks will do better as the U.S. transforms itself, painfully, to a more balanced growth model with a heavier emphasis on exports.

Gold Fell Sharply, Dollar Rallied on FOMC, But Trade Volume Is Weak

Trade volumes in FX was reported to be weak on the second trading day of the year, and while gold and commodities have seen sharp movements, it is not clear that this is the beginning of a multi-week correction trend. Gold, in particular, has lost more than $45 per ounce in another of its typical sharp swings, in anticipation of a stronger dollar, and some concern about the Chinese interest rates. FOMC minutes released Tuesday further boosted the USD-positive sentiment, since the committee appears to note some economic improvement, and refrains from making any kind of commitment to another round of QE. Core inflation, according to the minutes, has bottomed out, and while 2011 may see some upside momentum in prices, 2012 will bring price stability back. In short, we`re told, this is as far as the FOMC is prepared to go for now on QE, with no clarity provided on when on how the program will be ended.

We have seen such statements before. Even in October 2007, the FMOC member Randall Krozner was speaking about the importance of keeping rates at a reasonable level, about his concern about inflation expectations, and issuing forth stock statements in an air of seriousness, yet the same FOMC later brought rates to zero, as we all know, and there they have stayed till now. We don`t suggest that the Fed doesn`t know what it is doing, because that is the subject for a different debate, but we do mean that their statements on the outlook are no more important than any analyst report that would be issued with respect to their future actions. In other words, we don`t think that the Fed knows what it will do any better than the typical analyst, and the minutes are more valuable then analyst reports only because people short-term trade the markets with them.

The release emphasizes that the risks to the growth outlook are significant, focusing on the house price, and Eurozone debt crises. If these progress in a manner that weakens sentiment in the markets considerably, driving interest rates on mortgage, and consumer loans higher than where the Federal Reserve wants them to be, Ben Bernanke`s statements up to date ensure that the Fed will act.

On Eurozone issues, we note the impact of an article at PIMCO`s website. They seem to be getting out of Eurozone peripheral debt, which has had a rather strong impact on bunds and Treasury bonds according to reports.  German unemployment was released unchanged at 7.5%, while Eurozone CPI rose above the ECB`s two percent target at 2.2%, and is not giving any sign of easing unless the Euro finds some respite from the constant talk about its demise. While the ECB`s actions are often hard to predict, we don`t expect any rate increases unless the Euro goes into a stall.

Korea, Chile Intervene, Brazil  "Ready to Take Strong Measures"

The focus has been on other issues recently, but the wave of competitive devaluations is still with us, with two central banks intervening today in local markets in order to rein in speculative inflows yet again, and Brazil threatening to alter commerce and FX regulations, as well as reduce government spending in order to control the real`s strength, and facilitate lower interest rates. Of these announcements, we think that the Brazilian one is the most interesting, because it goes beyond the usually futile intervention threats in order to discuss the implementation of controls on capital movements which echoes of times before the 2000-2010 period.

Just to the west of Brazil, we have Chile intervening by purchasing an enormous $12 billion dollars in the market, building up its reserves, and pulling the rug from under the feet of peso buyers, at least in the short term. Short-term traders were naturally gutted in the course of this heavy-handed intervention, but others note that, unless copper prices recede from their high levels, the Chilean central bank will have to keep pumping pesos into the market, as the country is producing about 35% of the global copper output. Anything less than that, and the peso will find solid demand.

Bank of Korea was also seen actively selling the won against the dollar in Asian trading, but that kind of action is fairly regular nowadays.

USDCNY Still dormant, But Appreciation Will Resume as Hu Jintao Meets Barack Obama on January 19th

Hu Jintao and President Obama will have a face-to-face meeting in two weeks or so, and many people expect the Chinese to time the next leg of yuan appreciation to coincide with the visit. Yang Jiechi, the ill-tempered Chinese foreign minister, and Treasury Secretary Geithner, the main engineer of the Bush era bailouts, will meet on Tuesday to prepare the groundwork for the visit, in a process that will keep building up momentum. Just before President Hu Jintao visits the U.S., Robert Gates, the Defense Secretary will be in China to discuss some Taiwan-related arms sales issues that are understood to have angered the Chinese. So the hectic pace of U.S. - China dialogue will be maintained into 2011.

USDCNY was fixed at 6.6215 vs.  6.6227 of Friday.

We conclude by mentioning the troubles faced by DPJ`s veteran backroom dealer, career politician Ichiro Ozawa, who is facing pressure to resign after corruption and bribery investigations have been initiated against him.  He has told the PM, who has been calling for his resignation, that he alone and the Japanese people will determine whether he will quit his seat at the Diet. If Mr. Ozawa quits, it will at least give the PM some calm as he makes his final attempts to salvage his disgraced government in the eyes of the voters.

 

New EURUSD Testing 200-day MA; U.S. - China Focus on Trade and Currency Policy

EURUSD is testing its 200-day MA, always a significant resistance/support level, but this time the impulse is generated by the apparent strength of the U.S. recovery with ADP numbers providing today`s justification for the Euro sales. In Europe meanwhile, the CDS market is quiet, and volumes are light, but ECB officials are grumbling about inflation, but it is unclear if they will, at any point, move to raise rates. Clearly, raising rates is not what the market envisions for the ECB at the moment, although perhaps the same cannot be said about Europe`s citizens, who are feeling the impact of the depreciating Euro in the loss of their purchasing power. Matters have not yet progressed to a level that would make an ECB rate rise a serious possibility, but if the Euro continues to depreciate, and commodity prices remain robust, there is a chance that the ECB will have to raise a few times if only to maintain the facade that it is acting to ensure that its legal obligations are being met. Meawhile, in spite of a generally optimistic mood, Ireland`s CDS are back around the 620 bps level, which is the record set before the bailouts in 2010, but volumes are said to be light.

In the East, much of the focus is on the oncoming talks between the presidents of the U.S. and China. Today, as we noted here, Yang Jiechi and Tim Geithner met to discuss some of the usual points of contention between the two nations, and while neither side would like to see an open and public break, it is clear that the viewpoints are opposed to each other in most topics. The U.S. wants to convince China to adopt a position that is to the benefit of the Chinese themselves, while the thankful Chinese are more interested in defining what is good for them. Be it as it may, we believe that this year will see some interesting developments in this crucial relationship, and, as it is obvious that the Chinese will not cooperate with American demands, appeals to the WTO in order to sort out the trade disputes are highly likely.

Our assessment of President Hu JinTao is that he is an incorruptible traditionalist in both his commitment to the power of the CCP, and the role of China as benevolent contributer to world peace, even though this may not be appreciated in the same terms by outsiders. We believe, therefore, that the complaints and protests voiced by the Chinese are for the most part genuine, and not just the consequence of pragmatism or opportunism, as they are generally believed to be. But this makes the issues at hand even harder to resolve, because, as both sides see the bilateral issues from a perspective of morality and right or wrong, the tendency, the desire to compromise is lessened, leading to the deadlocks that we are observing. The U.S. has a lot of qualms about certain aspects of China`s economic model the predatory practices by government authorities against foreign companies, forced technology transfers, and the lack of intellectual property protection through legal channels. These are of course not new; but now that the symbiotic relationship between the U.S. corporate sector and the exploited Chinese labor force is less profitable, and open to question due to rise of domestic unemployment, that which was easily ignored yesterday makes it to the top of the agenda in today`s discussions. For the Chinese, not much has changed, since they would like to go on with business as usual for as long as possible, but that is certainly not a possibility in this fundamentally different world that we live in after the events of 2007-2009.

A breakdown of relations between China and the U.S. would be disastrous for the world, but we suspect that a significant worsening of relations is almost impossible to avoid given the difficulties faced by the rulers of both nations. American politicans need scapegoats, since they won`t get any more votes by telling the people that they are living with the consequences of their past excesses. Since the so-called Islamic Terrorism is no longer a matter of excitement nowadays, the most obvious target for blame is China, with its obsolete and  alien form of government, distant and foreign culture, large size, and its potentially dangerous ascent into world power status in the course of just 20 years or so.  The Chinese, on the other hand, have to control a jingoistic population that is already dissatisfied with the way the government handles international relations, and, if the economy slows down considerably, will probably demand a hardline approach to foreign affairs in order to continue to tolerate communist rule. Let`s not forget for a moment that the world is changing, and controlling a sophiticated urban population is not as easy as it is to keep a largely illiterate mass of peasants under the thumb. All these, and many other factors imply to us that the U.S.-Chinese relationship will go through some severe tests this decade.

Against all these the coming talks between Presidents Hu and Obama are important, but are unlikely to generate groundbreaking changes. In a sign of this, today the Chinese were repeating their conviction that the yuan issue is unrelated to the trade imbalance between the two countries, just one day after the President, National Security Advisor Tom Donilon, and Yang Jiechi met to discuss the issue of trade imbalances. The developments so far leave little cause for being very encouraged about how the matter, but we`ll continue to keep track of them because of their pivotal role in determining where the world economy is headed.

Will America Be One of the Best Performing Economies of 2011?

Three or four months ago, the U.S. was widely expected to slip back into a recession, from which we were saved, as most would remember, by Bernanke`s repeated comments that he will inundate the world in USD in order to ensure that the dreaded second recession does not occur. The response of the market has been positive, but beyond that, the necessities that would really sustain growth in the domestic market are still lacking. The U.S. consumer is unlikely to be dissuaded from saving more money when a large number of owners have their homes worth less than their projected payments, with no prospect of significant improvement in home prices, or the labor market in the short term. Exports provide the only real opportunity for reviving U.S. growth in consequence, but the main obstacle in this field is, of course,  China, and with the yuan remaining where it is, we find it difficult that this momentum will be sustained into the future.

At the same time, it is probable that the U.S. will be one of the best performing economies of 2011, although this does not mean it will regain its health, or that the government will find it convenient to withdraw the stimulus anytime soon. With China on the path to significant tightening, the Eurozone under pressure from speculation about sovereign defaults, and the rest of the developing world suffering from the impact of huge inflows that imbalance their economies, the U.S. appears like a true safe heaven. Nonetheless, the "bliss" of these days is being purchased at the cost of tomorrow`s happiness, so the outlook for America isn`t as shiny as it may look next year, if our assessment proves correct.

In any case, all this may not prove to be as good as it sounds, since if the American economy outperforms the rest of the world by considerable margin in 2011, the dollar will be boosted on anticipation of higher yield and returns, and in the absence of strong private demand, much of the boost will come from asset price appreciation, and paper profits, instead of growth in real sectors. This will not help the U.S. economy much, and instead worsen the situation in the long term, because it is obvious that the dollar must depreciate in order to allow a rebalancing of the East-West divergence, and the correction of the Asian growth model. If it turns out that U.S. capitalists are investing in the wrong fields just because they have a lot of cash which is not wanted outside of the U.S. (i.e. in Asia), the entire QE2 package will go to waste, as the dismantling of the existing severely deficient system will only be delayed for a short period of time.

The E.U. must make up its mind on what the most profitable choices are for both the periphery and the core nations that consitute the union, but they don`t seem willing to make the hard choices, and the sacrifices that are unavoidable. The Chinese need to move against speculation and bubbles decisively, and appreciate the currency so that they don`t keep accumulating cash for no reason other than hoarding it. But they don`t look like they are planning to do so any time soon. The U.S.  needs to recognize that the present track does not need anywhere, it did not work in Japan, and probably won`t work in America, and begin to consider seriously the future of the deficit, and public finances in general. The U.S. doesn`t seem to be planning to take any steps in this direction beyond cosmetic measures that are aimed to please everyone.

In short, we are faced with facts that nobody is willing to accept, and the desire to live like nothing has changed is overwhelming around the world. China`s rulers want to keep their subjects living hand-to-mouth in order to make sure that they don`t begin to think about the privileges of a democratic system. Americans want to borrow money without having any thought on how to pay it back. And the Europeans, as usual, just want to have consensus on everything, and in the meantime, keep doing nothing. It doesn`t sound like a great picture to us, and we doubt that you would find it very impressive either. That nobody is recognizing problems, and nobody is willing to address them until they are forced on them brutally by the markets is the main reason of our bearishness on stability. We are bullish on gold however, and bullish on the dollar vs. the Euro.

The lack of decision will not help the consumer, the worker, or the businessman, but it is arguably a genuine opportunity for the wise(!) speculator who knows how to exploit tensions and imbalances, while not getting carried away in the sentiment of the day. So now is the time to keep and maintain our positions, with a keen eye on the horizon for any sign that the hibernation of the world`s governments is going to end. When that happens, the markets will bubble up, and it will be the countdown for the get out for all those who have built their positions at times like these.

China Interbank Market Tensions Unnoticed

This week has seen some wild movements in the Chinese interbank unsecured lending market, which is benchmarked by the Shanghai equivalent of the familiar Libor rates, called the Shibor, and its equivalent in the repo market. Given how tightly controlled Chinese capital markets are, and the authoritarian powers of the government over private and public firms, it is a bit strange to see this kind of fluctuations, but the market barely took note, perhaps because not many people are following these statistics, and fewer yet are concerned. It is difficult to say that the recent tension will transform into something more significant, because the government could at any moment relax controls to avoid complications. But there is a threshold, to be sure, beyond which the damage wrought by the such turmoil is inelastic in the sense that what is lost cannot be replaced. We will be focusing on China, as usual, to see what exactly the developments mean.

The Financial Times is attributing the cash squeeze to an apparent scrambling for cash by SOEs and banks that lend to them in anticipation of aggressive tightening by the PBOC which will reduce the available lending channels significantly, and, we suspect, lead to a sharp reversal in real estate prices that are widely believed to be in the wild stages of a bubble.  The Financial Times quotes, "For instance, HSBC remind that the property bubble is in large part a joint creation of local governments’ use of land sales for revenue (about 60 per cent of total revenue for Beijing, Shanghai and Tianjin in 2009), plus the wild over-bidding by SOEs ..."

Much of the rest of the world, from Mexico, to Indonesia, to Turkey are well-informed about the kind of distortions and disinformation that can be created by the activities of SOEs the excesses of which have been the root cause of many crises and even defaults in the EM world during the 1980-2000 period. The Chinese, being the Communists that they are, have little option in maintaining some of these lumbering corporations in order to prevent rapid rise of the unemployment rate. And perhaps more importantly, the massive cash influx into the country easily allows any kind of sub-optimally performing enterprise to survive and prosper by various kinds of speculative activities, and investments that findgood returns, bolstered by the fiscal, and FX distortions engineered by the government. Clearly, such cash recycling that allows potentially loss-making SOEs and cash-tight local governments to prosper is one of the main reasons that the asset markets of the country are almost completely out of touch with reality.

The surprise rate rise on Christmas Day, and the hints, and the general understanding among analysts that the Chinese will continue to tighten considerably into perhaps the second half of the year, has apparently led to a rapid realignment among many of the drivers of the real estate bubble. It is well-known that crises and market crashes tend to follow aggressive rate movements by central banks, and it is possible to conceive that something of the sort will happen this time, as the bloated Chinese real estate sector implodes on itself creating economic chaos in the country. But we believe that it will not be the Chinese government, but the natural processes of the market, probably bolstered by strong protectionist measures around the world that finally deflate the bubble, because the government has always been extremely cautious about tightening and reining in speculation, even in the most uncontrollable stages of the Chinese stock market bubble which, incidentally, only collapsed in November 2007 through precisely such reasons. So while the movements in Chinese markets are meaningful, it is too early to reach strong conclusions about their significance.

In other events, the market focus is found to be on the NFP release tomorrow, after the ADP numbers of Wednesday set up expectations for a rather bullish number. We suspect that the past months may see some upward revisions, but we are skeptical about the significance of the ADP release, since the correlation between NFP and the ADP  data has been rather week over the past years.  In any case, some positive adjustment in the unemployment rate would be neither surprising nor very significant, given the size and scope of the Fed`s efforts, and the stagnant state of the labor market over years now. Similar to the case of the occasionally robust numbers from the real estate sector, it is unclear that any short-term strength in this field can have a long-term significance in the absence of fundamental readjustments in consumer mentality, U.S. and Asian bilateral relationship, growth models, and a devaluation of the dollar. We believe that the turnaround will only come once the American economy is firmly on the track to reverse course and explore alternative development strategies, with a smaller more compact finance sector, a larger manufacturing industry, a shrinking external deficit, and some steps towards reducing the public debt burden. As long as these issues remain, it is very difficult to project a permanent healing of the consumer psychology.

Today equities are mixed, the USD is higher against most currencies, but lower against the JPY, while gold is mostly unchanged, consolidating after the 3% fall early this week. Markets are awaiting the NFP numbers, and today`s main theme of discussion is the disappointing retail sales numbers from the winter season. On the whole, it is a reasonably quiet day, and perhaps the weakness in some markets is a consequence of the  uneasiness before the payrolls release.

Lacklustre NFP Release Fails to Move the Markets, as U.S. Debt Limits Are Debated

Friday we received the non-farm payrolls release, and once again, market`s reaction was very weak, contrasting to the past experience where we would frequently have monthly trends started or ended by the directions indicated by the numbers. This was the case, for instance, during the 2007-2008 crash where the slow reversal in Q4-Q1 employment numbers decisively reversed the previous uptrend that had been in place for many years in the risk market. Now, however, markets appear to be convinced that employment does not matter because the Fed will intervene so strongly in the case of multiple weak releases that risk assets will be on an uptrend perhaps indefinitely. This mentality is not a new phenomenon, but has been reinforced strongly by the Fed`s latest actions.

An addition of about 103,000 to the payrolls which brought the unemployment rate to 9.4%, was received positively by the bond market where prices risen again, while stocks and currencies have not reacted by much. Gold, similarly, was mostly unchanged. Our understanding is that the U.S. market is going to go higher, and employment numbers have little to no relevance, provided that another major shock does not damage stability.

Meanwhile, lawmakers are continuing their bickering over U.S. debt which the government demands to be raised by March 31st, or in the worst case April 16th. The ceiling is right now at $14.29 trillion, and to raise it congressmen from both the Democratic and the Republican Parties are pressing the government to present a long-term plan for budget cuts reaching up to trillions of dollars, in a bid to preserve their seats at the next election, and probably, in consequence of a little bit of commonsense and a feeling of responsibility too.

Could the Congress refuse to raise the debt limit? We do not believe that there is even a remote possibility that the debt cap will not be raised, since, as Geithner himself remarks in his comments to the Congress, failure to act would have consequences that would easily dwarf in their impact the experience of 2008 after the Lehman default. It is not hard to see that, if the default of Lehman Brothers could trigger a global financial crisis, the default of the U.S. government would trigger the armageddon for the financial world. But speaking now, and talking tough will cost nothing to the U.S. or to the representatives. And as such, the vocal opposition that we observe right now should not be taken to imply anything more than posturing to the electorate, since after all, if the U.S. went bankrupt, the lynch mobs that would crowd Washington would not be too kind on  Senator Conrad, Congressmen Erskine Bowles, or Alan Simpson, who now head the movement to discipline the administration.

But in spite of the charade - and not withstanding the possibility that the Obama administration will make some cosmetic changes here and there to appease the Congress and to find a compromise - the fact that this debate is now being had, and various possibilities and scenarios are being discussed is proof enough that the mentality of the boom days has been left behind firmly by the people and their representatives in preference for a much more austere and sensible outlook on finances, consumption and economic life. The same reasons that compel the government and the Congress to curb down on borrowing are depressing comsumption in the U.S. and investment and it is extremely unlikely that by allowing people to borrow more the Fed or any other branch of the economic leadership can reverse the trend towards thrift. Perhaps the Fed is preventing a sharper contraction through its actions and interventions; it is certainly a plausible proposition. But it is unclear that by doing so it is not protracting the elimination of the weak (in the corporate world), the survival of the stronger and healthier, and the properity of the smarter, the more competitive actors in the country. We know that the U.S. owes its strength and success to its merciless approach to competition between the powerful and the rich.I it is not clear that the Fed is not destroying this pillar of the American system by its actions, however limited its impact may be in terms of reviving the economy in anything longer than the immediate future.

Taken in this context, the NFP release is a small component of a much larger puzzle which is being dominated by factors that have little relationship to economics. We believe, in consequence, that what happens in politics has greater relevance to economic trends, and the duration of the bubble, than any mildly positive or negative economic data for the enxt few years.

Markets Focus on Today's Eurozone Debt Auctions, CDS Rates Rise, Stocks Fall

Market sentiment was dampened yesterday by today`s large debt auctions in the Eurozone, where the weaker members of the union will be borrowing at least $43 billion. Credit default swaps rose on Ireland, Belgium, Portugal, and while the CDS index that measures that default risk of Western European governments rose to match a record yield of 228 bps. There is a strong sense of tension all around the world as the results of these events approach.

Stocks were lower in response, and in Asia, Indonesia and India were the biggest losers. India`s not being treated very kindly nowadays after the scandals that shook the country a short while ago, while Indonesia is suffering from a worrisome inflation trend in line with the rest of the region.  In Europe, naturally, the falls were sharper, while U.S. markets performed reasonably well in spite of the tense atmosphere.

The dollar, naturally, gained against almost all of its peers, while oil rose on anticipation that Asian demand will remain strong. We are pessimistic on oil in the near term, and expect it to reverse course if the European problems intensify, or the Chinese aggressively continue with their rate rises. Commodities are likely to gain to some extent this year as the Fed continues its easy money policies, but perhaps the first half will not be as rosy as some seem to be expect. Gold, meanwhile, should stay on its upward track, notwithstanding the severity of its up and down swings as volatility remains high.

Today`s events are obviously of great significance. What we expect is that, while auctions will find sufficient buyers, in line with the trend of the months, rates will be higher, and money will be supplied at a high price. Regardless of the result, markets are unlikely to be convinced one way or the other, since lacklustre demand is unlikely to signify a withdrawal of borrowers, and a strong showing doesn`t imply much for the future. This makes sense, because the debt issues are long term and will not be settled by one or two auction`s results. If Ireland is shunned by creditors, however, we suspect that it will only trigger stronger European intervention, and not capitulation, as some commentators seem to expect. It is hard to see, as we like to emphasize, how they can reverse course after committing so much to the economic and political integration of the continent. And while perhaps dropping some aspect of the European Monetary Union doesn`t signify a lot from a pragmatic viewpoint, the same cannot be explained to voters in the region. All that convinces us that European politicans will only capitulate  when they are absolutely out of options, but with the Fed allied to them on the other side of the ocean it is hard to see how that even sort of situation would develop.

In summary we don`t expect much to happen as long the present governments remain in place. But we still believe that the Eurozone will disintegrate at some point in some way, only with the additional qualification that this development will be the consequence of powerful political events, and not some predictable surrender to speculators and the markets.

FX Headlines: Euro-Zone Industrial New Orders Disappoints, EURUSD Extends Losses

Industrial new orders in the 17 member euro area rose 1.4 percent in October after falling 4.2 percent the month prior amid expectations of a 1.5 percent increase, while the annualized rate jumped 14.8 percent.

Forex: U.S. Dollar Rally To Gather Pace, Euro Searches For Support

The U.S. dollar rallied against its major counterparts on Wednesday as fears surrounding the European sovereign debt crisis weighed on market sentiment, and the greenback may continue to appreciate going into the North American trade as investors scale back their appetite for risk.

EURUSD: Euro US Dollar Exchange Rate Forecast

USDJPY: US Dollar Japanese Yen Exchange Rate Forecast

GBPUSD: British Pound US Dollar Exchange Rate Forecast

USDCHF: US Dollar Swiss Franc Exchange Rate Forecast

USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

AUDUSD: Australian Dollar US Dollar Exchange Rate Forecast

NZDUSD: New Zealand Dollar US Dollar Exchange Rate Forecast

Forex Technical and Fundamental Forecasts for January

EURUSD: Euro US Dollar Exchange Rate Forecast

USDJPY: US Dollar Japanese Yen Exchange Rate Forecast

GBPUSD: British Pound US Dollar Exchange Rate Forecast

USDCHF: US Dollar Swiss Franc Exchange Rate Forecast

USDCAD: US Dollar Canadian Dollar Exchange Rate Forecast

AUDUSD: Australian Dollar US Dollar Exchange Rate Forecast

NZDUSD: New Zealand Dollar US Dollar Exchange Rate Forecast

GBP/USD’s Short-term Range Presents Scalping Opportunity

The GBP/USD erased the majority of its post PMI manufacturing gains as support swung in the dollar’s favor following a robust private employment report from ADP.

Crude Oil Falls Most Since November, Gold Plunges after FOMC Minutes

Commodities fell across the board as traders locked in profits and concerns about valuations emerged. Up on deck is the government report on U.S. petroleum inventories.

Forex: Dollar Climbs a Second Day as a Natural Reversal Effort Offsets Disappointing FOMC Minutes

Tuesday was a highly unusual trading day for not only the US dollar but for the capital markets in general. Falling back on the normal fundamental drivers, it would seem that the backdrop activity should have been relatively steady. Instead, various assets and currency pairs were exceptionally volatile; and more interestingly, there was a remarkable divergence in the performance of markets that usually trade hand-in-hand.

Gold Facing Formidable Headwinds After Ten-Year Rally

British Pound to Face Headwinds As Private Sector Activity Weakens

Japanese Yen Looks to Extend Gains On Falling U.S. Yields

Weekly Recap and Outlook for EURUSD - 11/29/2010

Last week's trading sessions saw EURUSD come off considerably after having closed the week before almost unchanged. The pair started the week off by gapping higher on Monday to make its weekly high of 1.3785 before then leading lower. The pair then fell sharply after Moody's Investor Services warned the market that it might have to make a multiple notch downgrade for Irish debt. The rating agency noted that the rescue package from the EU and the IMF would, "crystallize more bank-contingent liabilities on the government balance sheet, and increase the Irish sovereign's debt burden." Over the previous weekend, the Irish government had agreed to the joint EU/IMF bailout program, which is currently estimated to be between 80 and 100 Billion Euros.

EURUSD continued its sharp fall on Tuesday after reports of artillery fire between North and South Korea combined with the continuing financial issues in the Eurozone to send the pair lower. Nevertheless, Spain was able to raise 3.26B Euros in Treasury bills, which was on the lower end of the estimated 3-4B Euros that the debt auction was expected to raise. The Euro also came off despite a slew of relatively positive economic releases coming out of the Eurozone. These releases included German Flash Manufacturing PMI that came out at 58.9 compared with a consensus of 57.0, and German Flash Services PMI came out at 58.6 compared with an anticipated 55.9. In addition, Eurozone Flash Manufacturing PMI came out at 55.5 compared with an anticipated 54.4, while EZ Flash Services PMI printed at 55.2 compared with the 54.4 number anticipated. Also, the German GfK Consumer Climate survey was also favorable at 5.5 compared with an anticipated 5.1. In terms of U.S. releases out last Tuesday, Preliminary U.S. GDP came out at +2.5% for the quarter, compared with an anticipated +2.3%, while Existing Home Sales fell to 4.43M from 4.5M that was lower than the consensus call of 4.51M. Also out on Tuesday was the FOMC's Meeting Minutes for their November 2^nd and 3^rd meeting. The minutes showed that the FOMC had approved the Fed's new QE II package by a near unanimous vote of 10-1. The committee also downgraded its estimates for future unemployment, which is now projected within the 8.9% to 9.1% range for 2011, while U.S. inflation is now anticipated to rise somewhat but still stay below 2%. The committee also revised its growth estimate that now has U.S. GDP projected to grow by 2.4% to 2.5% for 2010, 3.0% to 3.6% for 2011, 3.6% to 4.5% for 2012 and 3.5% to 4.6% for 2013.

EURUSD continued dropping on Wednesday despite the German Ifo Business Climate survey printing at 109.3 compared with an anticipated 107.6. Nevertheless, EZ Industrial New Orders fell by -3.8% that was considerably worse than the fall of -2.6% anticipated. With respect to U.S. releases last Wednesday, Core Durable Goods Orders fell by -2.7% for the month that was significantly lower than the anticipated rise of +0.7% anticipated, although the previous number was revised significantly higher from -0.8% to +1.3% which neutralized the dollar-negative impact somewhat. U.S. Durable Goods also fell by a large -3.3% compared with an anticipated rise of +0.2%, but the previous number was revised upward from +3.3% to +5.0%. Also out on Wednesday was the University of Michigan's Consumer Sentiment Indicator which printed at 71.6 compared with an anticipated 69.5, and Initial Jobless Claims improved to 407K compared with an anticipated 434K. Nevertheless, U.S. New Home Sales came out at 283K that was considerably lower than the 311K anticipated.

On Thursday, EURUSD consolidated somewhat as U.S. markets were closed in observation of the Thanksgiving Day Bank Holiday, and no major Eurozone economic releases came out.

The rate then resumed its fall on Friday, making its weekly low of 1.3199 as the market speculated on whether Spain and Portugal might be the next Eurozone countries in line for a bailout from the IMF and the EU. The Dollar also benefitted from safe haven buying as geopolitical tensions increased among North and South Korea. In terms of economic releases out last Friday, German Preliminary CPI increased by +1.0% for the month compared with an anticipated flat reading, while the EZ M3 Money Supply increased by +1.0% for the year compared with an anticipated +1.3% increase. EURUSD then managed to recover a bit on short covering head of the weekend to end the week at 1.3247, showing an impressive fall of -3.3% net from the previous weekly close.

Fundamental Outlook for EURUSD

The primary market-moving economic data releases and policymaker speeches scheduled for this coming week in the Eurozone and the United States are as follows:

Eurozone:

The economic data week coming up in the Eurozone cools down somewhat in comparison with last week, and its important releases will feature the ECB Rate Decision scheduled for release on Thursday.

Since Monday has nothing of note scheduled for release, the somewhat active week starts on Tuesday with the release of the German Unemployment Change (-19K), the CPI Flash Estimate (+1.9% y/y), the EZ Unemployment Rate (10.1%), Italian Preliminary CPI (+0.1% m/m), and the Italian Monthly Unemployment Rate (8.3%). In addition, ECB President Trichet will give a speech in Brussels.

Wednesday will then offer German Retail Sales (+1.3% m/m) and EZ Final Manufacturing PMI (55.5).

Thursday's calendar includes EZ PPI (+0.4% m/m), Revised EZ GDP (+0.4% q/q), as well as the highlighted ECB Rate Decision and its associated ECB Press Conference in which the central bank is anticipated to keep its benchmark Minimum Bid Rate unchanged at the 1.00% level.

Friday then will end the moderately active week with EZ Final Services PMI (55.2), EZ Retail Sales (+0.4% m/m), and ECB President Trichet will give a speech in Paris.

United States:

The economic data week coming up in the United States is somewhat more active than last week, and the economic calendar will feature important U.S. employment data like the key Non Farm Payrolls number that is scheduled for release on Friday.

Monday will begin the quite active week with the tentatively scheduled release of the important U.S. Treasury Currency Report.

Tuesday will then offer the S&P/CS Composite-20 HPI (+1.2% y/y), the Chicago PMI (60.1), the CB Consumer Confidence survey (52.8), and Federal Reserve Chairman Ben Bernanke will give a speech in Columbus.

Wednesday's calendar looks particularly busy with Challenger Job Cuts (-31.8% y/y), the important ADP Non-Farm Employment Change (70K), Revised Nonfarm Productivity (+2.4% q/q), Revised Unit Labor Costs (-0.2% q/q), ISM Manufacturing PMI (56.3), Construction Spending (-0.3% m/m), ISM Manufacturing Prices (70.9), Crude Oil Inventories (last 1.0M), Total Vehicle Sales (12.1M), and the important Fed Beige Book all scheduled for release. FOMC Member Yellen will also give a speech in New York on Wednesday.

On Thursday, traders will be watching for Initial Jobless Claims (425K), Pending Home Sales (-0.9% m/m) and Natural Gas Storage (last -6B) to be released. Also on Thursday, FOMC Member Bullard will give a speech in Washington D.C., and FOMC Member Duke will give a speech in Philadelphia.

Friday will conclude the notably busy week with the scheduled release of the highlighted Non-Farm Payrolls data (+143K), in addition to the U.S. Unemployment Rate (9.6%), Average Hourly Earnings (+0.2% m/m), ISM Non-Manufacturing PMI (54.7) and Factory Orders (-0.7% m/m).

The Technical Picture for EURUSD

On the technical front, EURUSD gapped up at last week's open, but then peaked at 1.3785 and fell sharply to fill the gap. The rate then extended its previous week's losses by coming off as far as 1.3199 on Friday before closing a bit higher at 1.3247, showing an impressive fall of -3.3% net from the previous weekly close.

The rate currently seems to be furthering a deeper pullback now that the 23.6% or 1.3713 and the 38.2% or 1.3362 Fibonacci retracement levels of the move from 1.1876 up to 1.4281 have given way. Although the 14-day RSI is approaching oversold territory at 33 that could provoke a bounce during the coming week, no signs of divergence are yet appearing and the indicator remains firmly in a down trend. As a result, this sharp down move in the pair could still result in additional losses below 1.3199 toward the 50% or 1.3079 and 61.8% or 1.2795 Fibo retracement levels, especially if EURUSD continues to sustain losses below its medium term upward slanting former support trend line now drawn at 1.3253 that should now offer some resistance. The important break of this key trend line has now neutralized the former bullish outlook for the pair while it traded within a slightly diverging upward channel like pattern with an upward sloping resistance line that can now be drawn at 1.4629.

Furthermore, the rate also continued to trade last week below the key 61.8% Fibonacci retracement level at 1.3896 of the down move from 1.5144 to 1.1876, although it managed to bounce from just above the 38.2% level at 1.3124. Once again, this does not support a bullish outlook until the market moves back above 1.3896 at which point the rate's former 100% target level at 1.5144 would be reactivated.

In addition, as a result of the recent pullback in EURUSD, the rate now trades just above its 200-day Moving Average that is reading 1.3132 and has started sloping slightly downward thereby yielding a neutral medium term outlook for the pair. A sustained break below this important medium term indicator would be additionally bearish for the pair.

Also, the Bollinger Bands for EURUSD have widened considerably after last week's volatile price action. The rate has been bouncing along its lower Bollinger Band in the most recent decline that could now offer some support in the 1.3070 region. In addition, the indicator's center moving average line is now falling and provides resistance at 1.3659 along with the upper Band that now comes in well above the current exchange rate level at 1.4234.

From an Elliott Wave perspective, the corrective move to the upside in EURUSD seen since the 1.1876 low of June 7th has thus far shown two relatively impulsive waves, with an intervening correction. This move has now apparently completed a zig zag correction, with its final C wave peaking at 1.4281 that began at 1.2586 on August 24^th. The future near term direction for the rate now appears to be downward in yet another zig zag correction that seems to have already completed waves A and B, with a strong C wave to the downside still likely to come that should dominate trading over the coming week. Fibonacci Projection targets of the length of A off of the top of B at 1.3446 for the C wave that began at 1.3785 are 1:1 = 1.2950, 1:1.236 = 1.2753, 1:1.382 = 1.2631, 1:1.5 = 1.2533, 1:1.618 = 1.2434, and 1: 2 = 1.2115.

With the rate having closed last Friday at the 1.3247 level, the chart for EURUSD now shows support at 1.3199, at 1.3019 and in the 1.2903/21 region. Resistance to the topside is seen at 1.3343, at 1.3446 and in the 1.3776/85 region.

Overall, this technical scenario now looks as though the medium term corrective rally in EURUSD is in the process of correcting lower in a sharp zig zag pattern that should stay below the recent 1.4281 high point in the near term. Furthermore, other signs also indicate that a medium term top may now be in place and the medium term diverging up channel pattern has now broken convincingly to the downside. Accordingly, medium term traders may wish to consider selling EURUSD on rallies unless the 1.4281 level breaks decisively to the upside.

Furthermore, shorter term traders may also wish to consider selling rallies in EURUSD ahead of its former medium term trend line now at 1.3253 and its 200 day MA that is currently reading1.3132. An initial profit taking level could be suggested at the A=C wave equality objective of 1.2950, and below that at the 1:1.618 Fibo projection for the C wave at 1.2434.

Figure 1: Daily candlestick chart of EURUSD showing its 200-day MA in red, Bollinger Bands in green, Fibonacci Retracement levels in royal blue, Trend Lines in purple and the 14-day RSI in the indicator box in pale blue.