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To: c.hinton who wrote (11555)	5/20/2004 3:50:55 AM
From: c.hinton	Respond to of 108586

The Short View: The Fed's big challenge By Philip Coggan, Investment Editor Published: May 19, 2004 TIMES NEWS TRACKER Track news that interests you. Most commentators have been comparing current market conditions with 1994. Back then, the Federal Reserve decided to raise interest rates, in the face of higher commodity prices, causing bond yields to soar. There were signs of distress in the financial markets as carry trades were unwound. But Simon Derrick, chief currency strategist at the Bank of New York, thinks that a more apposite comparison might be 1998. Back then, the choice of currency for the carry trade was the yen, where interest rates were virtually zero and the currency was stable or declining against the dollar. In 1998, many investors had been borrowing yen to finance positions in riskier assets, particularly in emerging market debt. But those positions were rapidly unwound in the face of the Russian debt default, and the associated liquidity prices that led to the collapse of Long-Term Capital Management, the US hedge fund. As investors cut their positions, there were some remarkable moves in the currency markets. The dollar fell 8.6 per cent against the yen on October 7 (the largest one day fall in 25 years, according to Derrick) and initially tumbled another 9.4 per cent the following day, before rebounding. This selling was exacerbated, says Derrick, by the actions of options market participants who had sold options at below the precious dollar/yen rate. The sudden fall in the dollar caused them to come in and cover their losses. Derrick thinks that this time round, the dollar is close to levels against the euro and yen where investors may have set stop loss limits, either in cash or options. If those limits are breached, there may be a further surge in the dollar's value. Regular readers will know that I am not a great believer in technical analysis. But many people in the foreign exchange markets do use it. And clearly the actions of speculative money can move prices significantly in the short term. And the widespread use of speculative money to fund market positions became inevitable once the US Federal Reserve decided to set interest rates at their lowest level for a generation, in a bid to revive the US economy. Having let the speculative genie out of the bottle, the challenge is to get him back in again. The Fed will try to do this slowly, so as not to cause disruption in the financial markets. The big question for the year is whether the US central bank can pull that trick off. Thanks to Jennifer Hughes for highlighting the Derrick research.

To: c.hinton who wrote (11555)	5/20/2004 11:19:18 AM
From: isopatch	Read Replies (1) \| Respond to of 108586

Important: Found this excerp from the PIMCO article interesting and would like to use it as further evidence for the secular deflation that I'm expecting to hit next year: <While China still only accounts for 4% of global GDP, it consumes tremendous amounts of commodities and other nations’ exports at the margin – 20-30% of the world’s cement, nearly as much steel, coal, and iron ore, and 7% of all the oil. Increasingly, as China goes, so goes the rest of the world, especially its Asian neighbors and Japan. Estimates are that 40-50% of Japanese growth is China-centric. A Chinese slowdown of some magnitude will be a challenging development for the Land of the (recently) Rising Sun. Even if China stabilizes at a relatively high growth rate following credit and investment controls, there remains a perplexing secular problem in China that strikes at the heart of the global economy’s attempt to balance production and consumption. That dilemma after all has been central to our argument for “wet logs” in the past few years, and as we shift to a new metaphor, it is apparent that China/Asia holds a key to successful wire walking as well. With Europe and the U.S. heading towards either a demographically or finance induced savings mode, it would be hoped that the 1.2 billion potential consumers in China (and 1 billion in India) would pick up the slack. Problem is that the Chinese, Indians (and Japanese) like to save not spend, and that typically, private accumulated savings has to approach 300% of GDP before any semblance of “shop ‘til you drop” takes hold. China is years from that level. They also lack the financial infrastructure to facilitate a consumer led boom even if the spirit and body were willing. Credit cards and adjustable rate mortgages are not yet part of the Chinese consumer ethic. While the above is an admittedly brief summary of one of the global economy’s major secular imbalances, it describes a critical variable to any forward analysis: China’s wire walking needs to proceed briskly and with greater balance from internal consumption as opposed to investment – expenditures which currently exacerbate global supply.> Basically the above outlines one of my reasons for pushing the deflation thesis. There's going to be a dead zone where global demand drops. It's bordered on one side by a significant fall off in demand from US consumers driven by higher interest rates, continuing flat to weak real wages, and sub par job opportunity & employment. The width in time of the demand dead zone is predicated upon the time it takes to reach the other side of it when China, other Asian nations (with some assistance from the Eruo zone) will have enough viable consumer demand to replace lower levels of demand from US consumers. That <Demand Dead Zone> is where the secular Deflation is going to impact the global economy with a vengance. Continue to look at 2005 at the time for that to become clear to everyone. JMVVHO, of course. Isopatch