Venda do Novo Banco pode representar 8% do M&A na banca europeia este ano

[Merlin]

Catch 122 - the Next Big Move in Bunds and EUR/USD

This being a bank holiday Monday in Europe, I thought I would come up with some provoking calls for the markets! Let me first outline a quartet of important background points that are shaping my view for the months to come:

1. The Interest Rate Paradox:

Fed board member and most likely successor to Mr. Greenspan (Bernanke, AKA Let-me-lower-interest-rates-forever) announced in a July speech: "the fight against inflation is dead". But the money market is now pricing in 25 basis points of hikes before the end of March 2004 or as one analyst rightly commented: "...market is mindlessly projecting earlier tightening cycle onto this one"....

I have to agree with the "mindless" part. Every single speech and leak from Fed indicates the same pattern: the Fed will be slow to hike interest rates, and to prove the point, Greenspan now has Fed members talking to the press about how the Fed needs to change their public statements as the market continues to misinterpret their intentions.

All of this feeds into a new paradigm compared to previous easing/tightening cycles: the Fed, who - don’t forget - runs the monetary policy, thinks INFLATION IS DEAD. And when you believe inflation is dead, you will be slower, more gradual and more reluctant to tighten monetary policy in an economic recovery, if one happens to materialize. You basically believe the threshold for hiking rates relative to growth is higher than it has been historically.

2. The Europe/US Growth Gap Myth:

Market analysts, even my own, say that the consensus that is driving the market is the view that US growth is and will be more robust than Europe’s. Okay. Let's look at the latest set of GDP numbers, the Q2 numbers.

Headline US growth for Q2 was 2.4% and Europe was 0.0%. Looks right, so far. However, let’s consider that, of the 2.4% growth in the US, 1.7% came from increased defence spending! That's takes the 2.4% down to 0.7%. One more adjustment is also in order: Europe and the US calculate GDP in different ways, so much so that, had the US GDP been calculated in the European quarter-vs.-quarter manner, then US growth would be further shaved to a mere +0.3%. In other words, what looks like growth differential of 2.4% is really 0.3%. Toss in a couple of downward GDP revisions, as have chronically been the case in the US in recent years - and the difference may yet be erased entirely.

3. The 2004 Presidential Election: Like Father Like Son

My point is simple: Bush will not be re-elected. Look at history. Look at his dad. A high rating during a war campaign is a deathblow to your re-election chances. Following through on rallying behind the flag, is almost impossible to pull off. The weak economy heading into the 1992 election slashed 57 percentage points off the elder Bush's approval rating in the 16 months after the Gulf war, setting the stage for Clinton. Take a look at GW Bush’s present rating, its 53% and in a tailspin.

(Other examples: Jimmy Carter reaped 26 pct point during the seizure of American hostages in 1979......only to have the rescue mission to turn bad - and give Reagan a toehold. Lyndon B. Johnson’s approval jumped to 70% following the Gulf of Tonkin incident off Vietnam in 1964, but the failure of US military operations to secure South Vietnam drove Johnson’s approval rating down to 41 pct and provoked his withdrawal from the 1968 re-election.)

Iraq is slowly turning into a mini-Vietnam: 69% of people polled by Newsweek are 'concerned'. 40% are 'seriously concerned' and less than 18% feels confident in the US involvement. Not exactly the look of a political victory, and consider that the wars in Iraq and Afghanistan cost $60 billion a year!

4. Finally, the Recovery that Killed the Recovery Paradox:

The higher the expectations of an economic rebound, the more the expectations jeopardize the rebound! A catch-22. The market has already driven up the average funding costs of both corporate- and private US with the dramatic recent rise in long interest rates. Add to this the alarming rise in energy prices (unleaded making new highs....), and the stronger US dollar and you have all the ingredients for another major disappointment in the "miracle".

All of my points stem more or less from the same source: The economic revival is only real if you factor in the US government’s massive military spending. And unfortunately for this type of spending, it only has a one-off effect. Military spending is consumed when it is paid for, and has little residual investment value, unlike investments in schools, computers and other productivity driven projects. The US administration is basically taking the pool of capital available and shifting it from productivity driven projects to security driven ones. I am not judging whether is right or wrong, but it does change (read: reduce) the outlook for continued productivity improvements, and at a time where more and more industries in the US find that "shops" in the Far East can do their jobs at 1/10 the cost of the US!

It also requires a major reality adjustment in fixed income yields. I firmly believe that fixed income is close to ending its correction from June highs. The next up move will be the final one in this long cycle, which makes for 122.00 in Bunds (now 114.05),

On US dollar strength will also soon end. There is still an overhang of EURUSD longs in the market, but the low is still likely within the next 2-4 days with a strong rebound off the low and a final target of 1.22! The growth differential story will disappear and there is still an enormous need for recycling of US dollars into Euro from central banks. Finally, the US stock market looks at best shaky.


Final thoughts:

I do not expect to be right about the above, but I am certain that the market today offers huge benefits to those who are willing to separate hope from reality in terms of the underlying strength of the economy. The Fed is SHOUTING to us... we will not hike as there is no inflation and the growth is very 'critical'.

Bush is running out of steam; watch how the Democrats, not given a chance one month ago, will start getting traction.

So my three trades for the today, tomorrow and the coming weeks are FIXED INCOME, FIXED INCOME, and FIXED INCOME. Twist my arm, and I’ll add to this the flavour of Gold above 370.00 and Oil above 33$ and you know where we are heading...

1.22 in EURUSD and 122.00 in Bunds looks far off just now, but let's have another look at the end of December.

Steen Jakobsen

Saxo Fund Management

August 25th, 2003