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The Waiting Game
by Chuck Butler

Good day... The markets will play a waiting game today, and I expect the currencies to trade in a pretty flat range. The focus will be on the G20, which starts tomorrow, and the ECB announcement, which will also be released tomorrow. So today I will share my views on both of these topics, but first I will report on what occurred yesterday and overnight in the currency markets.

The dollar climbed yesterday morning as data released showed U.S. home prices plunged at a record pace and consumer confidence continues to bottom. U.S. home prices fell nearly 19% in January, according to the S&P Case Shiller index. This was even worse than economists had predicted, and December's numbers were revised down.

With housing continuing down and employment prospects dim, it is no surprise that the U.S. consumer confidence numbers remained near record lows in March. The Obama administration has been making an all-out effort to try and cheerlead U.S. consumers back into the old "borrow and spend" mentality, but the bad economic data are making its efforts futile. U.S. consumers continue to be hit with bad news and are going to need much more convincing before they start to rush out and spend again. I know this probably won't be popular with many, but is it really so bad for U.S. consumers to be tightening their belts? Yes, I know it may extend the recession, but I feel the U.S. consumer will come out of this much healthier if we can permanently break the borrow-and-spend mentality.

The global imbalances, which contributed greatly to the situation we now find ourselves in, need to be reversed. The Chinese need to increase their consumption, and the U.S. needs to increase our savings. This is the only way the world economy can move back toward equilibrium. So a depressed and scared U.S. consumer may be just what we need to correct these problems in the long run. I think it is foolish and shortsighted to try and encourage the U.S. consumers to start their old borrow-and-spend habits; that is what helped get us into this in the first place! (I doubt if you will see that spin on things anywhere else!!)

Recent economic reports in the U.S. had shown an indication of a pickup in consumer spending and a rebound in durable goods orders, causing a selloff in the dollar and a nice rally on Wall Street. But yesterday's Chicago purchasing managers index threw cold water on these nascent signs of recovery. Today I expect to see additional indications the economic slowdown will continue as we get the ISM manufacturing index, construction spending, pending home sales, and U.S. vehicle sales numbers.

We will also see our first indication of the monthly employment picture with the release of the Challenger job cuts number and the ADP employment change report for March. The Challenger number has already been released and showed the number of job cuts jumped 180% in March YoY. The ADP number is expected to show another 663k jobs were lost in March, slightly lower than February's 697k but still bad news for the economy.

But employment is falling everywhere. The European unemployment rate increased to 8.5% in February, according to a report released this morning. This is the highest since May 2006 and was above expectations. Japan also announced their unemployment rate yesterday, which rose to 4.4% in February compared to 4.1% the month before. The WorldBank and OECD released a report yesterday which warned surging unemployment will cause the current economic downturn to deepen and extend. The Organization for Economic Cooperation and Development (this is why they just go by OECD!) predicted that global GDP will contract by 4.3% this year as unemployment continues to grow. The WorldBank lowered its growth forecasts for developing countries this year by more than half to just 2.1%. In this environment, countries such as China, India, Brazil and Australia, which are predicted to beat these growth projections, will continue to be attractive targets for investment.

The deteriorating world economy adds to the urgency surrounding tomorrow's G20 meeting in London. The news media has set expectations unreasonably high, with looking for a solution to the global economic slowdown to emerge.

Unfortunately I don't believe we will see much come out of this meeting. The main focus of the meetings will be the establishment of new regulations for the global financial system. Treasury Secretary Geithner laid out his design plans over the past few days, which include greater regulation of hedge funds and the extension of federal regulations into the currently unregulated world of exotic financial instruments such as credit default swaps. It would also impose tougher standards on financial institutions judged to be so big that their failure would represent a risk to the entire system.

But leaders from Germany and France don?t believe these plans go far enough. In fact, President Sarkozy threatened to walk out of the meetings if the G20 doesn't put more teeth in the regulations proposed by the U.S. and the UK.

But U.S. financial firms still dominate the global system, and the job of regulating these firms falls to Geithner and the U.S. So while the rest of G20 may want to try and demand tougher regulations, the political landscape in the U.S. won't allow it.

Meanwhile President Obama will join the host of the event, Prime Minister Gordon Brown, to try and convince others in Europe to follow their lead and put together sizable economic stimulus programs to jump-start global growth. The U.S. has taken the lead on deficit spending (no surprise there!) with the administration spending $12.8 trillion in their stimulus efforts, close to the total GDP of the U.S. for 2008.

But leaders from Europe worry about the inflationary consequences of these huge stimulus projects and are hesitant to load up more debt onto the backs of their citizens. They don't want to risk the long-term health of their economies for a quick path out of the current economic quagmire. Can you blame them? I know Obama is an excellent orator, but he is going to have to be at his all-time smoothest to convince these other leaders to follow his lead. The UK and U.S. economies aren't a picture of health right now, and the quantitative easing measures they are pushing others to emulate are mostly untested.

While global financial regulation will certainly be a topic addressed during the summit, I can tell you a topic which won't get any traction: a move toward a global currency to replace the dollar. For all of the press China and Russia have garnered with their proposals the past few days, the U.S. will block any serious attempts to discuss an alternative to the US$. Much of the damage to the credibility of US$ as a reserve currency has already occurred. And regardless of whether an official alternative to the US$ is found, foreign countries will continue to diversify their reserves out of the dollar. Data from the IMF released yesterday showed the dollar's share of official foreign exchange reserves fell last year, while the yen and euro gained. The dollar accounted for 64% of the reserves, down slightly from the month prior. As with financial regulation, each country has its own agenda with regard to its reserves, and the trend away from US$ will likely continue, no matter what is or is not decided over the next few days in London.

Basically, each leader to the G20 summit is showing up with their own set of problems, and the U.S. and UK's problems are some of the worst. To think these leaders will be able to unveil a solution to all of these diverse problems in just 8 days is ludicrous. While the meeting will hopefully start us on the path toward global financial reforms, I am expecting the global markets to be disappointed with the lack of progress after G20.

The ECB will be announcing its rate decision tomorrow and is expected to make a 50 basis point cut in its main lending rate. The main topic of discussion on the currency trade desks is the question of quantitative easing and whether the ECB will look to follow the U.S., UK, and Japanese central banks.

The media's inflation/deflation pendulum has started to swing back toward inflation again, benefiting commodities. Gold gained almost $10 overnight as investors moved back into this inflation hedge. While the U.S. and UK are encouraging others to ignore the future consequences of pumping huge amounts of liquidity into their financial systems, commodities prices benefit in two different ways from this quantitative easing. First, some of the huge amounts of stimulus will be spent on infrastructure projects, which will increase demand for commodities. Also, if the stimulus works as planned, the economies will start growing again, which will cause demand for commodities to increase. Finally, the liquidity which is being pumped into the system will likely spur inflation, with commodity prices again moving higher. So commodities and those countries which produce/export them will likely be some of the best performers going forward.


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