Flash Update
FLASH UPDATE
October 21, 2007
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Watch the Greenback!
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PLEASE NOTE: Due to my being somewhat under the weather, the October newsletter most likely will be posted on Wednesday. This Flash Update reviews a couple of interesting developments in advance of the full monthly missive. -- Best wishes to all, John Williams
Last week saw some tumbling in stock prices and the foreign exchange value of the U.S. dollar, along with ongoing rallies in gold and oil prices. Those general trends still have substantial ways to go, but the dollar, gold and oil prices all are at relative levels that traditionally might invite heavy intervention by central governments or central banks. The rapidly weakening U.S. currency and successive record highs in the oil price promise a sharp pick-up in inflation, a mounting outflow of investment funds from the U.S. financial system and a resulting intensification of the still-festering liquidity crisis. The movement in gold reflects the increasing awareness of these problems by global investors.
The G7 communiqué offered an opportunity for the major Western powers to jawbone the circumstance, but none was taken. To the extent that any overt or covert intervention surfaces in the next several trading days, its impact should prove fleeting, as usually is the case. Although interventions often have been mounted to burn speculators, others have been designed to keep changes orderly. The market movements here have been broad, driven by extraordinarily strong underlying fundamentals, and likely already have been tempered by a certain amount of covert central bank activity.
Market hypesters and tipsters now are zeroing in on the next FOMC meeting, and a split in consensus -- whether or not the Fed will ease on October 31st -- is in play, with more than the usual nonsense being tossed around. For example, new claims for unemployment insurance rose from 309,000 in the week ended October 6th to 337,000 in the week ended October 13th. The big gain was hyped as a sign of recession and imminent Fed easing. Anyone who follows those numbers knows that the change in any given week is meaningless, and that big changes are likely in weeks containing holidays, because the Department of Labor cannot properly seasonally adjust for such a circumstance. The October 13th week included Columbus Day, when a number of state unemployment offices were closed.
As has been the case for some time, the Fed faces conflicting economic and inflation pressures. Not only is the economy going into recession, but it already is in one. The U.S. economy also faces significant inflation pressures from oil and food prices, a weakening dollar and explosive money supply growth. Yet, lower rates will do little to stimulate the economy, and higher rates will do little to counter inflation that, so far, primarily is driven by a commodity (oil) supply distortion.
The U.S. dollar's behavior remains the basic determinant of both the near-term and long-term outlooks for the markets. The primary concern for the Fed has to be the prevention of a financial-market meltdown, and the risks of such an event are the highest since before the 1987 crash. The fundamentals underlying those risks, ranging from extreme systemic leverage to extreme U.S. financial market dependence on foreign capital for liquidity, are unparalleled on an historic basis. Keeping investors in the greenback is key to maintaining market stability. Accordingly, rather than giving Wall Street another quick fix with a rate cut, my betting is that Federal Reserve Chairman Ben Bernanke will hold off on further easing on October 31st, with an eye to helping stabilize the U.S. dollar.
Whatever Fed action looms, the market expectations likely will be prepped in advance, so as to minimize any negative financial-market responses. Unfortunately for Mr. Bernanke, he is in a no-win situation, where the underlying problems should have been addressed 20 years ago, not patched over with successive monetary or financial-market gimmicks. Accordingly, I would place the odds on the Bernanke-Paulson market salvation team avoiding a massive financial-market catastrophe within the next year at well below 20%. Even now, severe financial-market turmoil could start at any time, with little warning, likely in tandem with heavy selling of the U.S. dollar.
Full details will follow in the October SGS newsletter.
The target for the October SGS has been moved to Wednesday, October 24th. An e-mail advice will be made of its and any intervening Flash Update/Alert postings.