Stronger USD outlook likely to rebuild savings

The outlook for the US economy is certainly weaker as the Fed steps into a revive the government owned agencies - Freddie & Fannie Mae. These agencies were destined to fail, and highlight the extent to which these government-owned agencies have been used to bankroll US property market investment. Foreclosures will need to be absorbed by the market before we can expect any rebuilding of confidence in US markets. So we might ask - what is the direction for interest rates? The way I see it, something has to give, whether its:

1. Higher inflation - its not going to be asset inflation, so it will have to be cost-of-living inflation
2. Weaker USD - this is if the Fed Reserve continues to subsidise credit in the USA
3. Higher interest rates - in order to rebuild savings in the USA - which will boost the savings rate, but will likely also strengthen the USD. There will need to be tax increases as well to finance government.

The Democratic (Clinton) tradition has been to rebuild savings after the Republicans (Reagan, Bush) have decimated the treasury. I would therefore expect increases in interest rates, higher tax and increased government spending. This will be a 'rebuild America' program, with a lot of flag waving and a strong USD. The implication is that the US is going to go into hiberation for a few years, so if you are looking for a growth scenario, you will be looking to Asia, and obviously Australia will benefit from that. Though without a strong US, we would be looking at a weaker growth scenario for Asia, and I would not be surprised to see domestic stimulus to rebuild the global balance. Expect property booms in Asia. There will be great opportunities given the current global weakness. The stronger phase will be in 5 years when the US does contribute.
---------------------------------------------------
Andrew Sheldon www.sheldonthinks.com

AUD-JPY faces a consolidation period

The AUD-JPY exchange rate is an important indicator of the carry trade. At this point, we are witnessing a consolidation in the AUD after it hit support around Y86. This consolidation is occurring because of the mix of good and bad news facing the Aust economy. The focus is on Australia because we see notthing happening in Japan. No reform, no significant stimulus. Just a reshuffling of party leaders. One day they are bound to get it right. The factors likely to underpin some strength in the AUD include:
1. Weaker interest rates is likely to see a rebuilding of interest in property investment
2. Certain metal commodities have remained fairly strong - coal, iron ore, alumina, gold
3. Australia's commodity focus & position in Asia mean it will fair better than other commodity producers - except perhaps South Africa (gold, platinum focus)
4. Increasing takeovers and investments by Chinese companies in Australian resource projects augers well for the country's future. Remember the impact Japan's investment had on investment. China's participation will likely be more significant.
5. Stronger food prices and rains I suggest will likely see a stronger rural sector, also helped by mining.

Those factors undermining the AUD are:
1. Lower interest rates is likely to place pressure on the yen carry trade, as funds are shifted out of Australia. NZ?
2. Business investment is going to result in greater outflows, mainly for mining. These projects will see the AUD rise high in future, but investors are short term focused so they will focus on the current account deficit, although it does strengthen economic activity, it does not flow through greatly to the retail sector.
3. The weaker global economic outlook is placing pressure on commodity prices, and thus those countries with commodities exposure.

Short term I am expecting a stronger Australia equity market, initially from the broader market, but thereafter the commodity-based markets should kick back in, and will rejoice in the greater interest by Chinese investors (mostly government enterprises) in our mineral & energy resources. I actually don't see a lot of weakness in interest rates because inflation is still high and spending will likely recognise the bottom. Until the global economy can see a problem, I think we are looking at the AUD going sideways against the JPY. The greater action will be the AUD-USD until we see more positive recovery in commodity prices.
--------------------------------------------------
Andrew Sheldon www.sheldonthinks.com