Good Evening here is your newsletter for w/c 17th November 2008

“When things are bad, we take comfort in the thought that they could always be worse.  And when they are, we find hope in the thought that things are so bad they have to get better” Anon

Even as the leaders of the G20 met this weekend in an emergency summit to discuss how best to prevent the world economy imploding markets continued to swing wildly from hope to despair and back again.  Quite what politicians hope to achieve while credit market remain frozen and banks continue to mistrust each other merely confirms their utter impotence in this catastrophe.    What is emerging is that no one political leader, banker of any description, regulator or economist has any idea of what to do.   Indeed the conclusion of the summit seems to be go home and do what you think is best for your own economies!

In the US we find the classic example of rearranging the deckchairs on the Titantic as Henry “Hank” Paulson’s dithers about the $700 bn bailout money.  Apparently it is now not to be used to buy up mortgages but instead deployed to prop up failing institutions (perhaps).   This, of course, assumes anyone actually understands what he is saying in interviews and speeches.   One could say he is to finance what Rumsfeld is to military strategy.

By Thanksgiving, which is next Thursday, banks have usually squared away their positions ahead of December’s financial year-end.  This would usually allow auditors time to sign off the accounts and the executives the luxury of planning how to spend their end of year bonus, which in the case of many usually amounted to the GDP of a small emerging country.    Such halcyon days are now just a dim and distant memory as banks now desperately try to find as much cash as possible to ensure they are still in business in the New Year.

Alongside the dysfunction in the credit markets we are also witnessing an unnatural dollar rally in the currency markets where we have the dollar rising on bad economic news and falling on positive.   This inverse relationship was particularly evident last Thursday and Friday.  On Thursday the Dow closed 552.59 points up having been down over 300.  As the Dow climbed in the last three hours of trading the dollar fell against the euro from 1.2520 to 1.2854.  The pattern reversed on Friday as the Dow lost 400 points in the last hour of trading and the dollar gained almost 200 points as the euro fell from 1.2797 to close at 1.2603.

For many traders and investors the concept that a rising Dow Jones does not necessarily equate to dollar strength is difficult to understand as it is so counter intuitive.  A rise in the Dow should lead to a rise in the dollar?     However, the relationship between the Dow Jones and the forex market is not to be found in the euro dollar pair but rather with the Yen crosses (the carry trade pairs) and, in particular, the euro/yen.   On Thursday afternoon as the Dow accelerated higher the yen crosses and their components all raced skywards.  From 2.00 to 4..00 pm the euro/yen shot up from 120.00 to 126.05.     Positive moves in the Dow and euro/yen are often taken as signs that market participants have perhaps recaptured their appetite for risk and that the worst may soon be over?  However, in my opinion these moves should only be viewed as a reflection of the continuing uncertainty and extreme volatility still present in the market and, with care, could present a short term trading opportunity.

Trading Tip:  With entire governments unsure of how to resolve their individual economic problems some are looking at previous measures such as exchange controls, nationalisation and protectionism.  Although each has been tried (and ultimately shown to have failed) we need to be aware of the implications if any of these measures are actually enacted by our respective governments.

The first is exchange controls.  Tried at various times in the past and now threatened by Russia as investors (and Russians themselves) stampede out of the rouble.  Russia’s problems have not been helped by the collapse of the oil price and its recent attempt to assert itself as a military force with its invasion of South Ossetia.

Sterling too is facing a crisis of confidence and has sunk to a 12 year low.  Gilt sales are falling and with the Governor of the Bank of England comparing the UK’s problems to an emerging market how long before the UK joins Iceland and Ukraine in establishing exchange controls?  Under normal market conditions governments would simply raise interest rates to stem the flow of money but in the current climate this is not likely to happen.

The second measure is nationalisation which in the UK has already taken place with Northern Rock and the government acquiring stakes in a number of other banks.  The US has already nationalised AIG and President Elect Obama also appears to favour a bailout of the car industry.

The third measure, and the one most likely to re-emerge, is protectionism which has always lurked below the surface in many countries.    Even before the financial crisis took hold, the failure to reach an agreement in Doha and the recent election of a Democratic president does not bode well for the concept of free trade.   Even if Obama were to offer support to particular UK industries which prompted other countries to retaliate the global trading system is already fragmenting as evidenced by the collapse of the Baltic Dry Index (explained in more detail in an earlier Newsletter).

Good luck and good trading.

Anna