FX News Trading For The Week Of June 17-And Beyond

With a fairly light week of data-perhaps this is a good time to take a step back to look at where things are and what things we are doing now to have trades that work with a high degree of certainty.

The biggest story of the the year as far as trading and understanding how money flows in a situation of high negative volitility ocurred back at the end of February in the "Shang Hai Surprise". The global equity sell-off that ensued caused a rapid "unwinding" in carry trades-or what I like to refer to as the "carry system of investment funding"(CSIF).

By understanding how money flowed in an emergency situation-we know how it will flow in a situation where investment is favored. The facts are that the CSIF is a poorly understand factor of immense proportions. There are no statistics that track it, and no published studies have been done to study its depth and effects, yet all you need do is to overlay some charts to get an idea that this the true money engine of the global expansion.

The confluence of past economic events and current patterns of global exchange, coupled with central bank policies that have kept inflation under control are being taken advantage of by the biggest players in capital markets to fuel a global growth engine that probably just getting revved up at this point.

Favorable economic data opens the gates and by reading the movements that occur-you can have trades that are as predictable, repeatable and profitable as can possibly be-if you know where to look and how to trade it.

The second biggest story of the year is the avoidence of a recession here in the US that so many had been predicting. While there are any number of factors that contributed to this, i'll outline three that I believe made some large contributions.

1. Globalization and the dollar's plunge

In an era of free-flowing investment and open trade borders-aka globalization-US multinationals were able to take advantage of other markets for their goods and services once the dollar depreciated and made their produts more competitive.

2. Historically low interest rates

The availability of capital at relatively cheap prices is the gasoline that the global investment engine runs on. As long as the money's there-investors will use it for M&A, stock buy-back and Capex.

3. The US Job market and consumer

Can be partially seen as a by-product of globalization. Yes, there are small pockets hurt by this, but the overall "whole" has clearly benefitted. The bottom line of globalization is that despite a weakening housing market and higher energy costs, the job market has supported the consumer and consumers have supported the US economy. The "soft landing" likely occured in Q1 2007.

I completely understand that this is the conventional wisdom put forth by those with a large vested interest in globalization (not you NewstraderFX). But the fact is that wages have stagnated for nearly all Americans during the last several years, regardless of skill-set or education level.

The American people have an excellent sense for when the economy is moving in a direction that benefits them. And they haven't had that sense for quite some time. That's why there's a "small pocket" that now totals 68% who believe the country is on the wrong track.

I really admire and appreciate the relentless, multi-channeled propaganda from the globalization crew who desperately want to convince the American masses that they're better off - when quite clearly they're not.

It's practically comical.

The 10y rate can really be looked at as the benchmark consumer rate. Pretty much everything that the consumer buys on credit-including a house-is based on the 10y rate. As it goes up, the consumer will face higher borrowing costs.

Back when the US economy looked to be heading towards a recession and the debate centered over the chances of a "hard" vs a "soft" landing, economists were naturally focused on the US consumer because spending by the consumer accounts for around 70% of GDP. Some thought that slowdown in housing would damage the consumer and thereby bring about a hard landing in the US economy. To this point, that does not seem to be the case.

As energy costs rose this spring, focus again turned to the consumer and how spending could possibly slow. It seemed the consumer might get "both barrels" at once-a depressed housing market and higher energy bills. Surely this double hit would take a toll on the consumer. Again to this point, no evidence of that.

Now comes the possibility of a "third barrel"-higher borrowing costs in the form of rising 10y rates. Can the consumer face threats from all three areas and still maintain spending at respectable levels? The question is still open. My opinion is that sustained 10y rates over 5.5% will slow the rate of growth in consumer spending and that as rates rise further, spending will be affected more and more.

If you want a good idea of what the Fed will do with interest rates and thereby what could happen to the dollar-watch where 10y rates go.

In the case of a rising 10y rate, growth and thereby inflation should continue to slow. In this case, the Fed's next move will have to be a rate cut and as this becomes more apparent to the market, the dollar will weaken.

In the case of 10y rates remaining relatively low, spending will likely be maintained (as long as the job market remains bouyant). In this case it's likely that growth and inflation will bottom and start to head back up, forcing the Fed to eventually raise rates. The dollar would strengthen as this became more apparent to the market.

What makes this very difficult to predict is that market forces have control of where the 10y goes. The Fed's influence is felt on the front end of the yeild curve although they can perform open market operations. It's actually in the Fed's interest to see the 10y slightly higher, because their inflation expections hinge on growth slowing enough to bring corePCE into their 1-2% target zone. We've actually seen this play out to a degree as a slowing GDP has brought about lower YoY core PCE and CPI inflation.

Sitting on the other side of this equation are China and Japan with their mighty current account surpluses and export-driven economies. Unquestionably, it's in their best interests to keep the US consumer going strong and one of the best ways to do this is by buying US debt and keeping rates relatively low.

We may have seen this occur last week. The 10y hit 5.3% and was immediately bought. Who did the buying? That can't be known right now so all we have is speculation. Then again, there's no clear answer at this point as to exactly why bonds sold off in the first place.

Stay tuned...

http://forexfactory.com/showthread.php?t=34595

Update of this thread in the N&A section:

http://forexfactory.com/showthread.php?t=34595