Egypt Concern Drives Oil Higher; Markets Mixed

Today is a mixed day for equities and currencies as the robust rally of the past few days becomes digested. In the uncertain environment of the moment traders seem to be determined to sticking to what they believe in, the bullish momentum that has been in place since Ben Bernanke`s hot money promise a few months earlier. Only oil seems to be directly impacted by the events far away in the Middle East.

Meanwhile, in Egypt events continue to progress in an unpredictable fashion, as President Hosni Mubarak`s point man and spymaster Omar Suleiman tries to find a graceful way out of the mess that his employer has placed him in. He seems to be appealing to the fears of the Egyptian people about a breakdown in peace and order, and focusing on the chaos that could break out if the protests go on without a compromise attempt by the opposition.

The regime has done everything in its power to maintain the appearance of a constructive partner, and not an obstructor to the democratization process, and at times even attempted indirectly to characterize the recent turmoil as the natural consequence of its liberalization program which, cynics would say, has been advancing slower than a snail for the past few years. And even that lacklustre program was in fact the consequence of the Bush Administration`s continuous pressure on its authoritarian allies in the Middle East; Hosni Mubarak was not the only one singled out for "guidance" by the Americans, with Jordan`s and Saudi Arabia`s monarchies getting their fair share of hints and suggestions about what should be done to prevent the emergence of a region-wide wave of extremism. That did not work out quite the way Washington had hoped, of course, since we doubt that they had any great excitement about getting the Muslim Brotherhood to power.

The absurdity of the situation in Egypt, and the speed and chaotic nature of events can be seen with greater clarity if one considers the fact that the Egyptian authorities` main partner in the talks, the Muslim Brotherhood, is in fact a banned group even now. Yet they are debating with Omar Sulaiman and his people about how to manage a peaceful transition of power. Power balances are shifting so fast that it is impossible to speak meaningfully about where the country is headed. It is not at all impossible that Egypt will transform into  a free but chaotic emerging market democracy, the scenario favored by most western observers. Yet it could also be overtaken by various more radical forces with extremely serious implications for the entire Middle East. We don`t claim to have any clear insight on where exactly events will proceed at this stage. 

Elsewhere, we have gold and oil appreciating, the latter more strongly on the back of Middle East concerns, while the USD remains without a clear direction against most majors. The momentum trade is still in place, and for now it seems like its drivers will not give up unless a really big shock comes out of the Egypt crisis.

Portugal`s Sovereign Yield Hits New Records; U.S. Jobless Claims Fall

Weekly jobless claims data is out as usual today, and the 36,000 strong fall from last week`s revised number has been taken with great excitement and optimism by the commentators, although the U.S. Market has not been very aggressive yet in its response, perhaps waiting for the NFP release. The idea is that we are really seeing the beginning of the end for the rise of unemployment, with the Fed`s stimulus finally working to generate some self-sustaining momentum in the private sector. Yet the number seems like a little abnormality, a spike that doesn`t seem to be strongly correlated with the improvement in the 4-week average which is still holding firmly above the 400, 000 level.

Regardless of the immediate outlook for the labor market though, it is hard to see how much worse the numbers can get because the wider measures of unemployment that factor in those who are not counted in the headline number are already deep in the double digits, and it does appear like by and large the large froth in the market has been eliminated since 2005. That doesn`t mean that employment figures will allow us a sharp and sudden improvement any time soon, and as Bernanke says, recovery is likely to be slow and protracted. But it does look like the U.S. has had it share of labor market troubles – it is now the turn of others, especially those in emerging markets who have not at all been punished for their role in the bubbles of the past decade. They go on as they did before the crisis, and that for us means that they are still waiting for their part of the pain when the market finally decides to deflate their bubbles. They may have some time before it happens, but at least the U.S. is not the focus when the crisis arrives.

We also note the strange rise in the yield of Portugal`s five and ten year debt, even as the market remains in a bullish mood. The speculation is that the Portuguese government has been reaching out to more aggressive segments of the market in order to sell its junk, preferring the shorter-term at possibly lower yields. It seems that this attempt is failing as the fast speculators seem to be buying goverment debt only to sell it shortly afterwards for quick profits, increasing supply at a time when there are no obvious buyers. It is a sign of the times that the government is looking for saviors among the wolves and jackals of the hedge fund world and its various arms (or maybe tentacles?).

Up until the release of today`s jobless claims data, markets were in a weak mood, arguably because they have been so bullish over the past weeks that they need to take a break and refresh before taking the next leg higher. There is no shortage of reasons for worry, but traders are for now willing to take the risks as long as the general sentiment remains upbeat.

U.S. Trade Gap Widens as Egypt Considers its Future

Trade data from the U.S. are out today and provide great hints on what is going on with the economy today. Leaving aside monthly fluctuations, we discover that the 2010 gap has widened at the fastest pace of the past two decades, with consumer spending on imported goods constituting the biggest driver of the trend in spite of the fact that exports have performed similarly strongly on ongoing demand from China and neighboring Asian economies. Put together with consumer confidence numbers released today, these figures confirm the understanding that the Fed was able to turn the economy around by its controversial and aggressive tactics. What remains to be seen is whether this success can sustain itself once the central bank`s support is withdrawn, and in that respect the data is inconclusive so far.

What we find more interesting from a longer term perspective, and also with respect to the USDCNY debate and related protectionism worries is the 17% jump in exports which is reported to be the largest gain since 1988. Car sales, and industrial machines are the main driver of the trend boosted by the fall in the value of the USD against most emerging market currencies in the same period. With manufacturing contributing an ever increasing share of U.S. economic growth it is becoming clear that the appreciation of the yuan will remain a top issue for the U.S. administration even if it doesn`t feel itself bound to pursue the Congress` timetable on the problem.

Meanwhile, before the release of these pieces of data equity markets around the world were doing well in part in a reaction to news that Egypt`s Hosni Mubarak has handed over the country`s day-to-day affairs to his deputy Omar Suleiman and left for the resort town Sharm al-Shaikh even as he refuses to step down as demonstrators have been demading. Coupled to this incentive, the leadership has been threatening the demonstrators too, with the Finance Minister speaking to the BBC`s Radio 4 about the possibility that the stalemate between the army and the demonstrators cannot "go on forever", and that fire may have to be used at one point. We don`t think that the army will shed blood in order to keep the bankrupt and corrupt Mubarak regime in place, so the minister`s worries seem to be exaggerated. It is most likely that the army will keep protecting the person of the president from any harm while doing nothing to openly alienate the protesters. Of course, in such a volatile situation anything may be possible, but the possibility of a general bloodbath of the sort that would happen in the 70s and 80s seems very low now.

Gold is slightly higher, oil almost unchanged as the USD shows a lacklustre performance in this bullish atmosphere. We expect US stocks to close higher as well, bringing the week to a fitting conclusion.

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.

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.

 

Egypt Calms Down, Markets Heat Up

Today is Monday, and the charts are green around the world. Stocks are rising, commodities are doing well, and the USD is weaker on the expectation that the Egyptian issue has been exaggerated by commentators, and that the strong resurgence of the U.S. economy justifies another leg for the equity bull market, as announced by the likes of Mark Faber and Mark Mobius.

In Egypt, the Vice President has declared the intention of the government to issue a draft list of changes to be made to the current system in order to allow greater openness, and faster democratization. Banks and the stock market are open today, and while demonstrations continue, it does appear like many in the democracy camp are impressed by the President`s new tactics. His pledge to step down, and to implement reforms within a credible timeframe certainly changes the picture in the country fundamentally. Although demonstrations calling for the departure of Hosni Mubarak are continuing, it is possible that the pressure is being kept on only to make sure that he doesn`t find the opportunity to withdraw his promises once the heat of the moment is gone.

Meanwhile, in the U.S., President Obama`s team is trying to keep as low a profile as possible in order to avoid becoming embroiled in a difficult and complicated problem the full details of which they may not even be able to grasp due to the diversity of actors and grievances involved. By siding broadly with the protestors, but at the same refusing to openly call the Egyptian leadership to quit, they seem to be hoping for an orderly transition to  a democratic system through the stewardship of Mr. Mubarak. It is too early to say if this strategy can work, but it seems more promising than the heavy-handed interventionist approaches of the neocons under the Bush administration.

The world market is on a rally mood, and this is likely to continue for a while. The Eurozone debt issue is on the backburner right now as speculators prefer to wait and see the size and scope of the E.U.`s new solution, and the market is confident that the rest of the world can continue to grow with U.S. demand and Chinese production creating the necessary bull dynamics over the short term.  At the very least, those who subscribe to this viewpoint have the Fed on their side, and historical experience shows that they are unlikely to fail barring a catastrophic change to the main scenario. We remain pleased with the direction of commodity prices, and especially gold, and see them as the best tool to bet on a bull market, however shaky and volatile it may turn out to be. 

China Raises Interest Rates Again; Markets Charge On

So what exactly is driving markets onwards these days? Certainly, China`s third hike of interest rates since the beginning of the current cycle should ring alarm bells for all but the most hallucination-prone members of the bull camp. Isn`t it Chinese purchases driving commodity prices higher? Isn`t it cheap Chinese products that keep the cycle going for those like Japan and the U.S., whose companies and consumers would get a severe shock if the Chinese workers were able to demand the just rises in pay that they deserve? And isn`t the Chinese banking system the third pillar of the global bubble, ensuring that even the craziest "investment" ideas will get funded? These and many other Chinese factors should make any believer in the bull phase extremely cautious and nervous about where the market is headed, including those brave souls who are brave enough to ignore the turmoil in the geostrategically pivotal Arab World, or the explosive E.U. But no, nothing matters for some except for cheap dollars and the same old game of borrowing to speculate, and that the Fed rules all.

The PBOC has raised its benchmark from 5.81% to 6.06% in response to inflation reaching the highest levels of the past 3 years. Chinese inflation has hit 4.6% in December as most readers of the blog would know, but it is a lot lower than the situation in much of the emerging market world. Put simply, there is too much money gushing in to these places and too little enthusiasm from central banks to combat the inflows through capital controls or interest rises. The outcome is rampant inflation, but inflation is probably the least of the ills that the discrepancy between advanced economies and the developing world will bring about. Above all, we have the boiling speculative bubbles that stretch all over the world from Turkey to South Africa to Israel and of course China. Bubbles characteristically end with rate rises (recall the gold and commodity bubble in late 70s that was killed by Paul Volker, or the stock market bubble in 2000 that was popped unwillingly by Alan Greenspan). If inflation causes interest rates to come higher, and causes these bubbles to pop, we may well have the worst economic disaster of the post-WWII era in a collapse that may well dwarf anything we experienced during the banking crisis. Because that one has been made to spread to all segments of the world economy by the experiments of central banks.

Commodities and EM stocks are the only ones for now to experience the reaction of the markets to the Chinese decision. We do not expect even gold to come unscathed if the Chinese keep tightening to perhaps as high as 10%. While that is a distinct possibility, we do not think that the PBOC will risk pushing the brakes too hard, as China will be one of the hardest hit when their engineered bubbles explode.

NFP Shows a Mixed Picture, Traders Focus on the Unemployment Rate

Stocks are universally higher today, and currencies like the AUD and TRY are performing well on the back of the anticipated improvement in U.S. unemployment picture, as well as the generally improved sentiment in Asia for the past weeks due to the stronger and stabler performance of the USD. Gold is also higher after rising by more than $20 yesterday.

Among today`s releases we are most attentive to the improvement in the manufacturing sector reported in the NFP release, which is fully in line with the long-term perspective of a U.S. economy that depends a lot more on manufacturing than it used to do in the past decades. The trend is in place, and will probably intensify in the coming years, since the depreciation of the USD, although slow, promises a great improvement in profitability of the sector. 

Euribor rises to 1.88%

Due to the uncertainties surrounding the future course of action of the ECB, and, to a much greater extent, the nature and scope of future bailouts, 3-month Euribor rate is higher by one basis point today, and is expected to go higher in the next months. The Euribor trend currently in place stretches all the way back to April 2010, coinciding with the beginning of the Greek crisis, and we expect it to define the Euro interbank market until a resolution is found.

The Germans and the French are experiencing some difficulties in finding a common ground over the size of planned bond buybacks, with the Germans generally opposed to greater commitment of funds, while the French support far greater flexibility in the availability of bailout cash.  Ireland and other bailout partners have been requesting less punitive interest rates, but this is opposed by the Germans who would like to see severe punishment discourage future errors.

January payrolls rise by 36,000; unemployment rate falls to 9%

U.S. NFP rose by a very modest 36,000 which is the smallest gain of the past four months, versus projections by analysts foreseeing a jump of about 146,000 for December. Construction, transportation jobs and the manufacturing sector are understood to have been badly impacted by the cold weather in the north, with some 707,000 workers reported having been prevented from going to work as a consequence, but even with this caveat the fact remains that the economy is still struggling to stage a significant improvement in the labor market. Excluding government jobs, the total rise in payrolls was 50,000.

At the same time the unemployment rate, which is calculated from a different sampling, fell to 9% against forecasts expecting it to come  between 9.2% to 9.6 percent. The household survey showed a fall of 590,000 in the number of unemployed. Revisions to the previous NFP numbers reaching back to 2006 have also been released, showing that the economy has lost around 8.75 million jobs in consequence of the recession, while adding 909,000 for 2010.

The report allows both the bulls and the bears enough room for revising and reforming their viewpoints, confirming that the labor market remains  very weak, but at the same time providing a more positive reading if one focuses on the household survey. On the whole, the report is unlikely to change anyone`s analysis to a great extent, especially because we know through Bernanke`s statements that the Fed is committed to maintaining its program for now. PIMCO`s Bill Gross is reported as saying that the Fed is unlikely to raise rates for the next 12 months, and we agree with this viewpoint, seeing a slim chance of any rate rise provided that the Fed is not forced to move in that direction by the bond market.

Egyptian Opposition Calls 1 Million to Demonstrate; China PMI weak

Tensions in Egypt continue to remain in the spotlight, reinforced by concerns about China and Eurozone inflation. The Euro is higher today against the dollar on better equity risk sentiment, and strong inflation numbers that have made some believe that the ECB may raise rates. Oil is holding above $90 per barrel, while gold is rebounding from its recent lows in the $1320s and trying to find a ground. Markets are unwilling to take the Egypt events very seriously so far, perhaps hoping that the regime will be toppled soon without much more bloodshed and turmoil in the area. But even if that turns out to be the case, the removal of Mr. Mubarak as a cornerstone of the prevailing unjust yet stable order in the Middle East would show that this analysis is faulty and inadequate, and we believe that the region will remain in focus for much of this year.

Husni Mubarak has authorized his newly appointed vice-president Omar Suleiman to negotiate with the leaders of the opposition today, even as protestors prepare for a one million man march on the capital city, Cairo. He also replaced his interior minister one day after appointing him in order to placate the demonstrators. The military is reported to have made it clear that it will not use force, recognizing the legitimacy of the protests. Meanwhile, the stock market and banks remain closed, both S&P and Moody`s have reduced the country`s credit rating to speculative grade, and international companies are reported to be evacuating their staff. Speculation is rife that the Suez Canal may have to be closed in consequence of the turmoil, and Brent crude has already hit the $100 mark.   

In Asia, the focus is still on Chinese tightening, but recent PMI data could perhaps slightly delay the interest rate rises that the PBOC is planning. The events in Egypt and the Middle East must be watched with attention by Chinese authorities, and while there is no indication yet that similar events will be replicated in China any time soon, it is probable that if the PBOC loses its control over inflation the effect on popular sentiment will be very unpredictable. This, and similar concerns related to cost of living, and popular sentiment will almost certainly keep the Chinese on track to tighten considerably this year barring a sharp deterioration in growth numbers.

The USDCNY has remained at essentially where it was since Hu JinTao`s visit to Washington.  Today, on the back of generally stronger risk sentiment, the currency has made some gains against the USD, but we doubt that the PBOC will allow a significant appreciation in the middle of so many uncertainties surrounding the outlook. Today`s manufacturing PMI came at 52.9 for January vs. 53.9 in December, the employment component slid to 49, indicating slight contraction, but input prices were still higher at 69.3 vs. 66.7. Clearly price pressures remain intense, and with money supply growth way above the targeted 16%, the government has a lot more to do if it wants to prevent inflation getting out of control.

A total yuan gain of about 3-6% probably remains the goal of Chinese authorities for this year. USDCNY was set at 6.5860 today by the PBOC vs. 6.5891 on Monday.

In Europe, most are focusing on strong inflation numbers, and the recently hawkish statements coming from the ECB chief, and other members of governing council. It remains unclear how serious the ECB is about going ahead with rate rises, but inflation and credibility concerns may force their hands. We tend to view any series of ECB rate hikes as an indication that the end of the recent rate increases around the world has come to an end, because we do not think that the global asset bubbles would be able to withstand such a shift in sentiment.

Until the Egyptian turmoil comes to an end, the focus will be on commodity prices, and a possible widening of unrest to a wider region in the Middle East. As many would recall, Iran has had its share of violent clashes and protests only recently, and nations all along the North African coast are ripe for change after decades of brutal, and corrupt rule by dictators. We`ll continue to monitor developments and update you as events proceed.

Mubarak Promises to Step Down; Markets and Egyptians Unimpressed

The era of Hosni Mubarak is finally over in Egypt as the President promises not to stand in September elections, and agrees to a review of qualifications for presidential candidacy, opening the way to the Muslim Brotherhood, and Muhammad ElBaradei to challenge his party NDP candidates. His suspected plan to replace himself with his son Gamal Mubarak is almost surely discarded by now, with Mr. Mubarak`s main concern limited to saving his legacy from being trampled by the hectic events of the past two weeks or so. Overall, it looks like the Egyptian president`s main concern is protecting his name in the face history`s verdict, and his honor from being smeared with the title of a fugitive president. Perhaps he may escape the latter, but if he does, he will have to be content with being the jailed president. 

The president`s rule has not been a complete failure. The fact that he has been able to protect the country from becoming embroiled in the dangerous Israeli-Palestinian issue is perhaps regarded as one of his major achievements by Western commentators, while the growth rate of the country under his leadership has not been lacklustre. But in both cases, the masses were disillusioned by the forceful imposition of the President`s vision, and were unconvinced that the President`s strategy represented the only viable, and the most profitable course for the country, and especially the poorer segments of society.

Hosni Mubarak has been one of the cornerstones of U.S. Policy in the region, as he remained highly predictable and friendly to the U.S. regardless of great changes and political turmoil. The collapse of the Soviet Union, the two Gulf Wars, the rise of China, and numerous conflicts in Palestine-Israel did not change the basic policy direction of Egypt, which has been maintaining a pro-Western, and almost pro-Israel stance since the days of the assassinated Anwar Sadat. Now that the President`s term is over, it is unclear whether this rosy alliance can be salvaged, especially because it has hardly any basis at all at the level of the electorate who are far more sympathetic to Arab causes than their leaders have been. At the same time, one must not overemphasize the nationalism of the impoverished Egyptian mass, as it is reported that almost half of the country live on around $2 per day. The main focus, therefore, must always be economics and survival for Egypt`s voters, provided that no Islamist takeover occurs.

Media sources have been worried about the latter for a while, but we don`t think there is a credible probability of it occurring, especially because the spirit of the times in the Arab World is against such a backward movement. Democracy is opposed only by a tiny group of radicals and fundamentalists who have little connection to the people at large, and from the highly influential Azhar University, to the main opposition movements in the country, the Muslim Brotherhood, popular rule remains by far the most common and sincere wish of political groupings. This is not surprising, since no segment of the population has been insulated from the arbitrary brutality of the Mubarak regime, and one can almost feel a sense of shared destiny among political actors as they confront the last convulsions of the system.

Markets have been mixed today, with Asia and Europe unsure about which direction to take in the face conflicting news and reports from the economic and political fields. This should be the case for a while, as the exit of Egypt`s president promises a great deal of turmoil for the region in even the most optimistic scenario, posing significant risks for commodity prices and interest rates. Leaders in the region are aware of this too, and just yesterday Jordan`s King Abdullah sacked his cabinet, Basshar Assad in Syria promised new reforms, and the Saudi regime took similar steps in order to avoid a repeat of Egypt`s events in their country. There is no shortage of candidates for the next leg of turmoil, and we`ll continue to monitor events in this exceedingly critical part of the world, and its repercussions in the wider global markets for our readers throughout the year.