fx_20140909

FX CONCEPTS FX CONCEPTS

GLOBAL MACRO RESEARCH

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CURRENCIES INTEREST RATES EQUITIES COMMODITIES

WEEKLY INDEX

MARKET INSIGHT REPORT............................................................. 2

The Future of the Eurozone ....................................................... 2

CURRENCY – Europe Long-Term View.......................................... 3

Somewhere Over the Horizon.................................................... 3

COMMODITIES – Long-Term View.................................................. 4

The Commodity Boom Is Over .................................................. 4

CURRENCY – Commodity Currencies Long-Term View............... 5

The Kiwi Clips its Own Wings.................................................... 5

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September 11, 2014






MARKET INSIGHT REPORT The Future of the Eurozone September 11, 2014 By John R. Taylor, Jr. Chief Investment Officer We often see the statement that the recent troubles of the Eurozone are not at all significant, as the monetary block has been pulled back from the serious problems that threatened its future in the years between early-2010 and mid-2012. On its surface that sounds reasonable, but thinking for a few minutes and examining some economic, monetary, and social statistics over the last five years points out the deeper underlying realities that have done nothing but worsen over time – and in some areas dramatically so. If the underlying numbers are so much worse, how can we say the Eurozone is not in worse shape than it was in late 2011 or in the first half of 2012, when most would argue the outlook was the most pessimistic? Back then I wrote a chapter, “What History Tells Us about the Euro’s Future” for Sara Eisen’s book Currencies after the Crash. My piece focused on the social and political differences among the countries, as well as the longer-term population issue. The status of every one of the issues, which I raised at that time, has not improved. The underlying problem is not liquidity, as it is only a symptom of the reality of the systems beneath it, but the nature of the political economy of each society within the Eurozone. As politics is the art of the possible one can’t ignore that what is possible in any country derives from the social and economic realities of the society involved. What politicians can do and expect from the voters of Germany is far different from what is politically possible in Italy or Greece. The social milieu of each individual country has not changed and no effort is made to harmonize them, a process that would take generations. And the critical economic statistics still deteriorate: lower growth, higher government debt levels, continuing deficit financing, declining internal trade within the Eurozone, and increasingly disparate growth statistics. The situation is worse than it ever was. What will the future bring? The ECB, the only Eurozone central authority, has decided that the strong euro has had a negative impact on inflation and growth on the one hand, and wants to stimulate bank lending to the private sector on the other, so has gone to negative deposit rates. By penalizing banks with excess liquidity, the ECB has made the euro hard to hold. The euro is declining. That is it and there is no question about it, but when will it stop? Who will stop it? The most likely candidate to put an end to this decline is the United States acting through the G-7, and we don’t expect that to happen until the EUR/USD is approaching par and dragging down all other currencies against the dollar as well. This will have a positive impact on Eurozone exports and import substitution and will stop the slide to deflation. It will bring the US closer to deflation, and force other currencies to protect themselves from deflation and trade deficits by driving their currencies lower as well. Unfortunately, without a better capitalized banking system, which is hemmed in further by the AQR and Basel III rules, this devaluation of the euro will be very slow to translate into growth. Because, of the four largest economies, only Spain showed positive growth, and all economic numbers are already pointing to a weaker second half of the year, we believe the next year will start off in recession. As the rest of the world should be doing well, the Eurozone will lift itself up through the current account once again, but this is no way to manage a developed economy – penalizing your citizens and exporting all you can. Politic tempers deteriorate in a situation like this. Luckily there are few big elections, only Spain in December, but the extreme parties and press will increase their calls for change. Life will get meaner on both sides of the Alps.






CURRENCY – Europe Long-Term View

Somewhere Over the Horizon By Joseph Palmisano What started more than four years ago as a banking and sovereign debt crisis has decayed into a growth crisis that is now enveloping the three biggest economies. Germany is teetering on the edge of recession, France is mired in stagnation, and Italy’s GDP is barely above its level when the single currency came in 15 years ago. Since these three countries account for two-thirds of Eurozone GDP, growth in places like Spain and the Netherlands cannot make up for their torpor. Not surprisingly, investors are getting out while they still can. The money that flowed into European equities at the start of the year, when there was a widespread view that the continent was finally starting to recover, has fled over the summer. It’s not a region anyone wants to invest in anymore. The underlying causes of Europe’s new ills are three very familiar and interrelated problems. First, there is a shortage of political leaders with the courage and conviction to push through structural reforms to improve competitiveness and, eventually, reignite growth. The big countries have wasted the two years bought by Draghi’s “whatever it takes” commitment. Second, public opinion is not convinced of the urgent need for deep and radical changes. Third, despite Draghi’s efforts, the monetary and fiscal framework is too tight, throttling growth, which makes structural reforms harder. At the same time, the political outlook just keeps getting worse. In the German region of Saxony, the anti-euro Alternative for Germany (AfD) party recently won it first seats in a regional assembly. French Prime Minister Manuel Valls faces a battle to push through even the modest reforms he has proposed. And Italy’s young reformist PM Matteo Renzi will soon see his popularity slide if he cannot deliver growth. Without a new push from the continent’s leaders, growth will not revive and deflation will take hold. Japan suffered a decade of lost growth in the 1990s, and is still struggling. But, unlike Japan, Europe is not a single cohesive country. If the currency union brings nothing but stagnation, joblessness and deflation, then some people will eventually vote to leave the euro. Thanks to Draghi’s promise to put a floor under government debt, the market risk that financial pressures could trigger a breakup has receded – for now - but the political risk that one or more countries decide to storm out of the single currency is rising all the time. The euro crisis has not gone away, it is just waiting somewhere over the horizon. The euro has been locked in a downward spiral against the dollar for since its peak in early April, repeatedly reaching fresh lows for the year. An economy that is doing little more than stagnating, along with an economic revival in the US, will continue to weigh on the euro. We expect it to fall much further in the quarters ahead. The 1.2660 level should be seen by the week of October 6. The single currency could fall to 1.22, a level it has not seen since June 2010, the height of the European debt crisis, by the end of the year. When the next significant low arrives in February we could be at new lows for the last decade.






COMMODITY – Long-Term View

The Commodity Boom Is Over By John R. Taylor, Jr. Prices of iron ore and coal are hitting lows in China, the US crops are overwhelming storage space, the energy sector is burdened with oversupply, and the metals complex has turned south again. The cyclical picture and trend channels also scream that the upmove is over. Although the very long mega-cycles of 35 years plus-or-minus a few years are somewhat undependable, we have argued over the last decade or so that the peak should come in 2015 – considering how clear the 1980 peak had been. With this break below our channel pattern that occurred several weeks ago in early August, we have to argue that we have seen the high of this cycle (a bit early) – the equivalent of 1980. If we are right the decline should be precipitous, even more like the one in 2008 than the one in 1980, but almost all declines of this type are very aggressive. The next cyclical low should be seen in December or possibly January. Our target is the 560 level which would put us at the low back in June 2012, which we see as a somewhat important low for this market. From that June equities rallied to where they are today and a month later the EUR/USD rally began. So if there is any chance that this decline does not turn into a rout, the Goldman Sachs Commodity Index will have to hold that 560 area. The shorter-term picture argues that we have just passed the perfect time for a medium term high in this index – around the 610 level – and the direction over the next three weeks should be down. We would not expect to see the Index move back above the 610 area and if it does we would have to expect a rally into early October – but we think this is very unlikely. Much more likely, the Index will break through support between 599 and 600 and reaching the 582 level by the end of the month. A move to the 575 level is possible but less likely. Early October should see some strength but by the second half of the month we expect to be headed down again.






CURRENCY – Commodity Currencies Long-Term View

The Kiwi Clips its Own Wings By John R. Taylor, Jr. Governor Wheeler and the RBNZ jumped into the fray and pushed the New Zealand dollar lower very early on Thursday, but the RBNZ has had a lot of company among the analytical community. Although the currency dropped by almost a percent in the past 24 hours, Wheeler’s actions probably will have little impact on the trajectory of the Kiwi. It is already dropping as fast as a flightless bird would and is very near its terminal velocity already. The NZD/USD should fall further today, but on Friday we expect a bounce at least into late Monday and possibly into next Wednesday, September 17. The bounce, if we can call it that will be held by the .8260 to .8300 area and then the currency will drop to our first target on the chart at the right, identified by the red box centered on the .8000 area around the week of October 6. As one might expect looking at our chart, our interest here is not Wheeler’s latest comments but the very long-term picture for this currency. If we have made a mistake here – and we certainly have – it is looking for a bounce (and we have done it again). Our latest letter on September 5 was titled Kiwi Should Steady for a Week. Although we argued you should sell on any strength, we have not really seen any. In that same letter was a piece entitled, The Commodity Boom Is Over, and that is the real point. The chart on the right puts the situation in a picture format. There the New Zealand dollar, after reaching almost exactly the last day of July 2011 high, has turned sharply lower and has broken through the uptrend line, which started in 2009. This decline looks roughly similar to the first three months of the one that started in March 2008 and then accelerate lower in the second half of July. If the timing were to be the same, the acceleration would start in the second half of October. Our target for January is the .7300 to .7500 level, which would equal the low back in November 2011, hit after the first thrust down from the Kiwi’s first all-time high. The longer term picture we have shown is a double top and the target of that is around the .5800 area, a level that would equal the very long-term upchannel from the major low in late 2000 around the .3850 level. The rate of change of the NZD/USD over the past 14+ years from that date is 120 points a year, about 1.5% to 2.0% on average over that time-span. It seems to us this would be an appropriate rate and we would not regard the Kiwi as substantially undervalued until it went below the .5800 level. Remember, the last 15 years have seen a spectacular run higher in commodity prices and the dramatic growth of China. How can it get any better? Australia has not been the only lucky country, New Zealand has been as well.

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