No-Fly Zone Imposed on Libya; G7 Sells the Yen

Libyan government officials were scrambling today to prevent events overtaking them. Just one day after declarations by the Colonel that his forces would have no mercy in Benghazi, the rebel headquarters, the foreign minister of the regime was declaring a cease-fire and speaking ambiguously about the appropriateness of the U.N. Resolution enforcing a no-flight zone over the country. The events in Libya and the Middle East appear to be headed for a lull for now, but the changes of the past two or three months have been monumental in terms of their effect, and are unlikely to have reached their climax yet.

As expected, the BoJ today intervened in the FX market, supported by the central banks of the G7. We regard this development as the termination of the JPY uptrend, and expect the government to borrow aggressively in the domestic market in order to finance construction and rebuilding projects. With U.S. objections to intervention eliminated in consequence of the earthquake and the ongoing nuclear crisis it is but a matter of time before the BoJ gains the upper hand against speculators. The U.S. was only interested in saving face against China and was never serious about Japan`s FX interventions and the earthquake will serve as a suitable excuse to let the BoJ have its way. The country`s FX reserves are likely to remain at high levels, provided that no major commodity price spike occurs.

Markets were upbeat today, in response to reasonably positive developments related to the nuclear crisis, and various bullish data releases from companies in the U.S. Gold and oil were higher, and the USD was lower against riskier currencies, while safe-haven government bonds depreciated slightly. Markets would like to forget about oil and Japan as quickly as possible, and with so much cash floating around and being pumped by the Fed and the BoJ it is no surprise that the bullish mood remains resilient in the face of very severe challenges.

As we end the week, we are left with the nuclear issue and the Libyan civil war as the main issues dominating the headlines, but it is our opinion that instability more than any specific problem is the theme of the quarter, as more and more crises erupt at seemingly unexpected times and quarters. A lot of people have been expecting a crisis in the Japanese government bond market, but we don`t think that the occurrence of a devastating tsunami and a nuclear crisis was in anyone`s mind. As such, and in alignment with the dominant cyclical trend driving events, we expect more shocks and higher volatility to determine market direction for the foreseeable future, even as stock prices appreciate on the back of government interventions and distortions caused by them. Gold remains our favored investment choice in a balanced portfolio that does not depend excessively on the performance of any asset class, with a healthy proportion of cash and related holdings. 

War breaks out in Libya; Stocks Appreciate

We leap straight from the nuclear chaos in Japan to a war in Libya, and even as the former shows some signs of gradually coming under control, the new crisis in North Africa is apparently only beginning. The main difference between the Japanese crisis and the Libyan War in terms of their relevance to the market is that while the Japanese shock could have easily crashed any rally, the Libyan War may be put forth as an excuse to appreciating oil prices and commodities due to the peripheral role of the country and its resources in the overall scheme of things.  In other words, we do not believe that the war itself is a major threat to overall market sentiment, other factors remaining constant.

In Libya, the West has a new war after Colonel Qaddafi violated a U.N. Resolution passed one day ago by refusing to halt the assault of his army on rebel positions. Libyan airpspace is now closed to  planes, and bombs of various kinds are raining down on the regime`s Army and its various facilities. The assault is apparently directed on military targets alone, and there are no plans of attacks on power plants, TV stations or other kinds of civilian infrastructure that had been commonplace during the NATO assault on Serbia more than ten years ago. This means that the military campaign is less costly than it could be in terms of public relations, and the coalition is easier to maintain, but it also means that it may be quite harder to achieve a decisive result inside Libya. One important result of this state of affairs is that the upward pressure on oil prices may be longer lasting than many traders would assume.

In Yemen, the last props of President Ali Abdallah Saleh`s government are crumbling as his own tribe calls him to step down, and a prominent general in the army defects to the rebel cause in the aftermath of bloodshed. It is unclear how many more leaders will sever their ties to the regime, what action they will take, and how high the risk of a civil war is in the country. But Yemen`s regime is agreed to be a highly corrupt, and an inefficient one even by the standards of the region, so support for it will not be very enthusiastic. Events are generating their own momentum, and with a few exceptions, risk of upheaval in Syria, Jordan, and other dictatorships in the region is rising with each passing day. This situation, in turn, should contribute to keeping gold, and oil, relatively supported for some time.

In Japan, the cost of rebuilding is expected to reach $250 billion over 5 years. Engineers are reported to have restored power to the nuclear facility but steam continued to leak from one of the reactors on Monday.

EURUSD stays above 1.41, USDJPY rallies strongly to beyond the 80 handle, while risk pairs such as the AUDUSD remain supported with a general market rally around the world. Speculators are convinced, it seems, that the nascent U.S. growth has a while to last in part because it is generated by fundamental dynamics, and in part because of the Fed`s support. We do not expect stock markets to suffer a long lasting collapse from now on, with the Fed`s clear commitment to inflating the economy, but volatility is surely to remain a major fixture of the scene for a long time to come.

Libya Fighting Calms Down as Stocks Around the World Rally

After yesterday`s important events were accounted for, markets looked to regain the bullish mood once again. The fall in U.S. home prices has not had a perceptible negative impact overseas, nor was the response in the U.S. strong enough to necessitate a reconsideration of long-term viewpoints. Perhaps traders are pleased that with the pressure on consumer net-worth exerted by falling house prices remaining in place, the Fed will be unwilling to adopt any radical measures to curtail speculative activity indirectly, or to fight inflation risk.

In the Middle East, a little bit of a stalemate is in place after the events of the past few days, and it is reported that while loyalist forces are too afraid to launch an open assault on rebels, due to Coalition airstrikes, the rebels remain too weak in terms of equipment and training to stage a major offensive against their enemies. Leaders of the Coalition against Colonel Gaddafi are worried about such a stalemate becoming entrenched, and there is increasing talk of arming the rebels coming from both sides of the Atlantic. In Syria, President Basshar Assad is expected to give a speech outlining his reform proposals, but it remains unclear how serious he is. His own supporters staged large demonstrations in support of the regime in many cities yesterday, and it looks like the rule of the Assad family is in no risk of a quick collapse anytime soon. Oil prices remain stable in response to these developments, with WTI a little lower, while Brent crude is slightly more expensive than yesterday.

In Asia, we are especially interested in reports of the new "copper as collateral" paradigm shaping the Chinese bubble, where it is reported that companies exploit latencies in supply and delivery of copper stocks in order to finance speculation. The article in the Financial Times blog is certainly worth a read for anyone curious about how the greatest bubble in the history of mankind is developing. While there is no sign yet that the game will be over soon, we believe that the PBOC and the Chinese Communist Party are committing a fatal mistake by refusing to restrain the creativity of China`s speculators more aggressively. It is especially worrying, and strange, that no precautions are being taken to prevent the diversified techniques of financial "innovators" in the country, in light of the fact that their deeds are counteracting the goverment`s tightening measures..

Stocks around the world are higher before U.S. open, while risk sentiment among currency traders is somewhat more mixed. News of an apocalyptic tone continue to come from Japan, and no end to the crisis appears to be in sight. Attention is focused on tomorrow`s NFP release, where anything less than a solidly bullish number indicating an employment gain in the 200k range will be regarded as a disappointment, although the short term price reaction remains as unpredictable as ever.