One Hundred Reasons To Worry!

One Hundred Reasons To Worry!

By forexnews on Feb 24, 2011 02:22:25 GMT

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Global markets have been sliding this week and the flight to safety trade has been in full effect. The unrest taking place in N. Africa has the markets on edge and has helped catapult oil prices to over $100/barrel.This is mostly a function of the risk premium that has been priced into oil, as there is fear that the unrest will spread to other governments, particularly Saudi Arabia who is a major supplier of oil to the world. $100 oil has a psychological effect on consumer behavior, and has a real effect on consumer prices.

No matter what metric the government uses, higher energy costs mean that business have to charge more to get their goods to market. Gasoline costs more, as does heating oil and jet fuel. The problem with the Fed and their take on the situation is that they do not consider the effect of loose monetary policy, but only look at the cause.

Whether higher oil prices are a function of risk premium, supply and demand, or monetary policy matters not. What does matter is what the Fed does to help curtail these prices. A story is being floated this morning that Saudi Arabia is going to increase their supply of oil to the market, but this is not a supply and demand story—yet. Whether Bernanke likes it or not, US monetary policy does affect oil prices because oil is priced in US dollars.

So get ready to see some inflation come down the pike. $100 oil is here to stay for a while. Do not expect the government to report it to you through CPI data. Expect them to explain it away by diverting attention to the unrest taking place in N. Africa and possibly elsewhere. But make no mistake about it, loose US monetary policy is the springboard that has allowed oil to catapult to these heights. Whether or not they want to do anything about it is another question entirely.

With gold re-testing all-time highs and oil back to a 2-year high, the flight to safety trade is in full effect. Conspicuously absent from gains this morning is the US dollar. So there are some currencies trading on their own fundamentals, but that could change if risk aversion takes over.

In the forex market:

Aussie (AUD): The Aussie is somewhat higher, after a report showed that business investment climbed in the 4th quarter and the conference board leading indicators index also increased.

Kiwi (NZD): The Kiwi is lower against all but the Dollar as the aftermath of the earthquake and the devastation it caused is fully digested by the market.

Loonie (CAD): The Loonie is finally trading higher against all but the Yen as oil prices eclipsing $100 have outweighed risk aversion in the short-term. (Click chart to enlarge)

Euro (EUR): The Euro is mixed, trading lower against the commodity currencies but higher vs. Dollar and Pound. Mixed data in the Euro zone has had little effect on the Euro. In addition, the Swiss franc (CHF) is trading at all-time highs to the US dollar. (Click chart to enlarge)

Pound (GBP): The Pound is lower across the board as CBI reported sales came in worse than expected, showing a reading of 6 vs. an expectation of 28. In addition, a BOE policy-maker re-iterated his stance that rates may not need to rise to combat inflation as the economic recovery is fragile. In this battle of hawks vs. doves, tomorrow’s GDP report will see who is more correct at the moment.

Dollar (USD): The Dollar is weak, weak, weak despite the risk in the market and higher commodity prices. US durable goods orders came in slightly lower than expected and initial jobless claims came in under 400K which was better than expected, but the real story is the flight to safety trade is taking place in the Japanese yen, Swiss franc, and gold.

Yen (JPY): The Yen is stronger across the board as it is the major beneficiary of the flight to safety trade. CPI data is due out later tonight and is expected to show continued deflation.

$100 oil is indicative that prices are going to rise for just about everything. This means inflation. There is no way around it. This threatens economic recovery because policy-makers need to decide whether or not to try to combat inflation, or to let it grow to attempt to scare people into consuming now for fear of paying higher prices later.

I don’t think this tactic is going to work, as people are too fearful to take on long-term debt to do things like buy homes, and may be content to make do with what they currently have. So this will end up back-firing on Central bankers and will produce stagflation.

Should they decide to return to normalized monetary policy, then this could help bring prices back to sustainable levels and provide more comfort to those looking to consume, as they do it out of confidence and not fear.

Until that happens, keep you eye out for inflation. Pay attention to the prices you pay for things and become your own “inflation index”. You can’t trust the government to do it for you.

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