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Wednesday, May 7, 2008

Dollar Smile, Global Decoupling, Oil Super Spike and Yields


When I first posted about the Dollar Smile Theory in January 2008, there were no obvious signs of economic weakness in Europe. Sure a bank or two had stumbled, but the economic numbers stilled looked robust.

It was only because Europe was lagging, not because Europe had miraculously avoided the credit and real estate bubble that economic numbers held up for a while longer.

The EURO has been SMASHED down from $1.60 since.
Gold has been SMASHED down from $1000+ since.

Related Posts:
The Dollar Smile Theory, Overbought Euro
The Dollar Smile Theory
Commodities Unravel, Confidence Collapses

European Retail Sales Drop by Record on Rising Costs (Update3): “European retail sales declined 1.6 percent in March, the most since at least 1995 and twice as much as economists forecast, as soaring fuel and food costs sapped consumer spending.

The drop in euro-area retail sales from the year-earlier month is the largest since the data series began more than a decade ago, the European Union's statistics office in Luxembourg said today. From the prior month, sales declined 0.4 percent. Economists had forecast a 0.7 percent annual decline and a gain of 0.2 percent from the previous month, according to Bloomberg News surveys.”

The Global Decoupling Theory is garbage. I’ve said that from the beginning and it has now become undeniable. However, the markets haven’t yet fully priced this in. While the Asia indices have corrected significantly, Latin American indices have not.

“Even unemployment at a record low has failed to spur spending. Confidence among households in France dropped to a record low last month, while a European Commission index of sentiment in the euro area also fell in April.

Retail sales in France declined 0.8 percent in March from the year-earlier month, while sales in Germany, Europe's biggest economy, dropped 1.1 percent, today's report showed.”

These economies too shall fall into a recession. They have to.

Related Posts:
Oil and Global Decoupling Theory
Global Decoupling Theory, Correlation Contagion
The Global ‘Decoupling Theory’ is Garbage
Asia Tanks

Of course none of this is immediate. For example, oil looks hell bent on one final speculative blowout. There was talk about an OIL SUPER SPIKE yesterday.

Goldman's Murti Says Oil `Likely' to Reach $150-$200 (Update5): “Crude oil may rise to between $150 and $200 a barrel within two years as growth in supply fails to keep pace with increased demand from developing nations, Goldman Sachs Group Inc. analysts led by Arjun N. Murti said in a report.

New York-based Murti first wrote of a “super spike” in March 2005, when he said oil prices could range between $50 and $105 a barrel through 2009. The price of crude traded in New York averaged $56.71 in 2005, $66.23 in 2006 and $72.36 in 2007. Oil rose to an intraday record of $122.49 today on speculation demand will rise during the peak U.S. summer driving season.”

Increased demand from developing nations won’t drive oil much higher. Developing nations are the new marginal consumers. That is to say they are the most price sensitive elements of oil demand. For first world nations oil demand is very inelastic. For developing countries oil demand is far more elastic. That means for every $1 increase in oil, more demand will be choked off in developing countries than in first world countries.

Translation: Long before high oil prices cripple the SUV driving commuter making $48 201 (2006 US median annual household income) the Chinese factory worker making about $7 700 (2006 Est.) or the Indian worker making $3 800 (2006 Est.) will have given up on certain consumer amenities.

It is a serious mistake to assume that commodity prices at these levels won’t have a serious affect on these developing nations.

Right now it is FINANCIAL demand that is driving the price of oil rather than real economic demand. So a SUPER SPIKE may well be possible but it will be speculative in nature and short lived...

While still range bound, yields along the entire curve have moved up significantly. The further out on the curve, the more significant the move higher. This is most definitely NOT what Bernanke had in mind when he started cutting. The market is not supposed to take away his rate cuts...

The 2 year yield is above the Fed Funds Rate (FFR). Do not expect anymore rate cuts.

Yields at current levels have worked to trigger a switch out of equities and back into fixed income. This has worked since December 2007. With this recent run in equities, I would expect that some profit taking there would be in order and a rotation into fixed income now that yields are more attractive. A stable to rising dollar helps make fixed income more attractive as well. So the stage is set for a rotation out of risky assets… in the US at least.

3 comments:

MAB said...

Ninja,

Good post. Again.

I can't help thinking that Goldman needs someone to buy their oil contracts before the price drops $50/bbl.

Also, people have no idea the amount of leverage that is used in buying commodity futures. Wait untill that leverage suddenly unwinds.

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