The Hong Kong stock market jumped 2.1% yesterday, is at a five-week high, and is now over 23,000.

Hong Kong is an interesting market. It enjoys the rapid economic growth of mainland China but not the high interest rates. The reason is that the Hong Kong dollar is pegged to the U.S. dollar and therefore must mirror our Federal Reserve's moneytary policy.

High growth + low interest rates = a winning combination.

Yesterday, the U.S. dollar rallied hard and gold tumbled. That fall in the yellow metal looks to continue today. Clearly, my short-term outlook for gold –which had been bullish -- is subject to change.

Looking at the charts, you can see that the dollar is now back ABOVE former overhead resistance …



While gold appears to be breaking down, and is testing its recent uptrend right now.

When these things happen a trader has to ask himself where he went wrong. Clearly, I was placing too much emphasis on the problems facing the U.S. dollar – problems that were reemphasized last night with terrible earnings from Washington Mutual. WaMu reported a $3.3 billion quarterly loss Tuesday -- far worse than Wall Street was anticipating -- as it set aside more money for bad loans. And earlier on Tuesday, Wachovia delivered terrible earnings news. My fears about the banking system seem to be playing out. So why isn’t the U.S. dollar going down?

The reason for that lies overseas – in Europe. As my friend and crackerjack currency analyst Boris Schlossberg wrote this morning:

“the latest EZ economic data has been horrid with Industrial Orders dropping a whopping –3.5% versus –1.5% forecast. Demand has clearly fallen off the cliff for the region’s producers and unless it rebounds quickly is likely to translate into weaker labor market data in the near term. Under such conditions that chances of another ECB rate hike this year is practically nil, as the monetary authorities in Frankfurt will come under enormous political pressure to remain stationary and perhaps even entertain a rate cut.”

At the same time, Treasury Secretary Hank Paulson spent Tuesday voicing support for a “strong dollar” while Federal Reserve Bank of Philadelphia president Charles Plosser said that that the U.S. central bank should raise interest rates ``sooner rather than later.''

So, the economic news on Europe weighed on the euro at the same time that Paulson and Plosser whipped up support for the greenback. This was enough to shift the tides on the charts. With the dollar up over overhead resistance, technical analysts rushed to buy the dollar and sell gold.

And THAT’S pretty much why gold swooned yesterday.

You can’t fight Mr. Market (or you’ll become poorer if you do), but I'll point out a few things …

1) Secretary Paulson has been voicing a "strong dollar policy since he was appointed in 2006, and his predecessor John Snow said he backed a strong dollar since George W. Bush's first term. What has happened to the U.S. dollar since then?

Indeed, Secretary Paulson’s support for the strong dollar has become the oft-repeated “check is in the mail” lie of the U.S. financial system.

2) Whatever the problems are in Europe, did the European governments just increase their national debt by 50%? That is in essence what the U.S. government did when Paulson said the “implicit” Federal guarantee of Fannie Mae and Freddie Mac has become an “explicit” guarantee. The two companies own or guarantee $5 trillion in home mortgages. That's just under half of the $12 trillion U.S. mortgage market. In comparison, the total U.S. government public debt totals $9.5 trillion. (In addition, Fannie Mae and Freddie Mac have $831 billion and $644 billion. respectively, in bonds outstanding.)

3) Why anyone is listening to Plosser now is beyond me. He argued against cuts in two Fed decisions this year, and no one listened to him then. And if anything, the U.S. economy is weaker now than it was then.

Nonetheless, while I consider the bullish dollar case weak, obviously Mr. Market has other ideas. Now, looking forward, what could weaken the dollar and strengthen gold?

Well, the U.S. Beige Book comes out at 2 pm today. This report on economic conditions is used at FOMC meetings, where the Fed sets interest rate policy. If the Beige Book shows recessionary conditions, the Fed may see the need to lower interest rates in order to stimulate activity.

The extent of the US slowdown will be reported in today’s Beige Book due out at 1600 GMT. Traders will be watching for any reports of particular weakness from the Fed districts across the US and the greenback may come under pressure later in the day should the news prove overly bearish. In the meantime the market remains very constructive for dollar longs as the unwind of the oil trade causes further euro selling. If today’s oil inventories figure pushes crude below 125/bbl then EURUSD could tumble below 1.5700 in sympathy.

I’m going to go out on a limb here and say the Beige Book will show both recessionary AND inflationary conditions. That puts the Fed in a pickle. But with sentiment on the dollar now bullish, bearish news on the economy could put the greenback under pressure.

On the other hand, if today’s oil inventory numbers (out at 10:30 am) push the price of oil down, the greenback could get another boost from that.

Does this short-term strength in the dollar and weakness in gold change my long-term outlook? Not a bit. Paulson may talk a good game, but the U.S. financial system and the U.S. dollar are in serious trouble. This pains me, because I love my country and like anyone with dollars in his wallet, I get hurt along with everyone else when the dollar goes down. But I think it’s prudent to use short-term pullbacks in gold to take longer-term bullish positions in gold AND silver. They will pay off down the road when the chickens come home to roost for the greenback. My intermediate term target on gold remains $1,210 an ounce.

The ramp-up in credit risk in the market is huge. The pound is acting well today on the back of market risk.  But, in the recent past the Swiss franc has been the star currency that has acted very well on risk, for two reasons we think:

1) Switzerland still hanging on to some reservoir of safe haven status in times of global trouble (and despite severing its gold link to its currency, it is still has a larger gold backing than any other of the major currencies).
2) Swiss likely still benefiting from European carry-trade status – Because of Swiss low interest rates, many actors across Europe funded a lot of risk asset investments and real estate (now becoming a risky asset); as they reduce this leverage and pay back Swiss denominated loans, the Swiss franc benefits accordingly.

  
Above is a daily chart of the British pound – Swiss franc cross rate.  We think the Swiss should outshine the pound on this ramp-up in risk.  If it does, we could see a sharp break lower out of this narrowing range.

From Chartpatterns.com:

“Symmetrical triangles can be characterized as areas of indecision.  A market pauses and future direction is questioned.  Typically, the forces of supply and demand at that moment are considered nearly equal.  Attempts to push higher are quickly met by selling, while dips are seen as bargains. Each new lower top and higher bottom becomes more shallow than the last, taking on the shape of a sideways triangle.  (It's interesting to note that there is a tendency for volume to diminish during this period.)  Eventually, this indecision is met with resolve and usually explodes out of this formation (often on heavy volume.)  Research has shown that symmetrical triangles overwhelmingly resolve themselves in the direction of the trend.  With this in mind, symmetrical triangles in my opinion, are great patterns to use and should be traded as continuation patterns.”

And as you can see when you step-back to the weekly chart, the trend in the pound – Swiss pair is definitely down…

Regards,

Jack & JR

Batten Down the Hatches – It should be a wild one!

First, the European Central Bank is set to announce their latest interest rate decision very shortly. Second, US Non-farm payrolls are reported 45 minutes after that.

Expectations:
 
The ECB hikes by 25 basis points and moves to a more neutral tone with monetary policy.

US Non-farm Payrolls, in the wake of yesterday’s poor ADP numbers, has the potential to severely disappoint with worse-than-expected numbers.

So where does the dollar stand ahead of all this? Not very comfortably at key support:

 

If today’s tag-team combination pushes the US dollar index convincingly below the upward-sloping channel we’ve marked in the chart above … well …. let’s just say recent history hasn’t served the dollar kindly after a break like this.

We’ll learn a lot about dollar sentiment when the dust settles today.

Regards,

Jack & JR

Central bankers all across Asia are raising interest rates, including the Reserve Bank of India increased its key rate to 8.5% last week.

The reason is simple --- inflation is taking off. The most recent inflation numbers showed inflation rising at the fastest pace in 13 years to 11.4% in India.

As I expected, the Fed announced today that they would hold interest rates steady. Also, as I expected, they talked a bit tougher on inflation. But that’s all it is – talk! 

While there are likely to be loads of market swings this afternoon and tomorrow, the bottom line is this: Nothing the Fed said will change the long-term decline in the value of the U.S. dollar … nor the uptrends in natural resources and inflation. Those trends are far more powerful than the Federal Reserve, or any combination of central banks, for that matter.

And actions speak louder than words. Bernanke has so far failed to back up his tougher talk on inflation and desire for a stronger dollar with any action whatsoever. And he’s not about to start now.

Reason: The weaker dollar and rising inflation are the lesser of two evils. Deflation is far worse an outcome than inflation, and there is not a central banker or politician who thinks the opposite.

At least one country is serious about fighting inflation.

The Indian Central Bank raised interest rates for the second time in two weeks. The Reserve Bank of India lifted the repurchase rate by 0.5 percentage point to 8.5%, the biggest move since 2000, and adjusted the cash-reserve ratio by a similar margin to 8.75%

Why is our Fed being run by Mr. Magoo?

Forgive me if this post meanders a bit -- there's a lot of stuff that I feel like commenting on ...

First, the newly-hawkish Federal Reserve may be having second thoughts, according to Robert Novak at the Washington Post. From a column that's up on the Post's website today ...

"Bernanke, according to sources, disagrees more with the European position than is reflected by his public statements. In his June 3 speech, he said that the jump in oil prices could simultaneously slow already low economic growth while raising inflationary dangers -- recalling the "stagflation" of 30 years ago. Privately, Bernanke is said to be much more concerned about low growth.

"According to these reports, Bernanke feels that oil at $125 a barrel and $4-a-gallon gasoline threaten contraction more than inflation, despite the daunting prices. The depressing impact on the oil-driven American economy is especially menacing in his view. Bernanke knows that he faces difficult choices that his lionized predecessor never had to confront. Indeed, the traditional tools of the central bank may be inadequate to the task.

"There is no question that the low-key Bernanke is calling the shots at the Fed. Lack of control by him was suggested June 5 when Jeffrey Lacker, president of the Richmond Fed, and Charles Plosser, chief of the Philadelphia Fed, in separate speeches took issue with the March bailout of Bear Stearns. But regional bank presidents play a minor role in setting monetary policy, and the other Federal Reserve governors go along with their chairman."

Second, the Saudis are pledging to raise oil output by another 200,000 barrels per day, beginning next month. That move would increase supply by just 0.2%. After briefly pulling back on the news, oil futures are spiking again (up by about $4). Why? I think it's this renewed "no tightening" talk. The Group of Eight nations also failed to call for a stronger dollar over the weekend. Both factors are causing the dollar to lose steam (it's down about 1.24 cents against the euro as I write).

Third, we continue to get economic data that underscores the stagflationary economic backdrop. The Empire Manufacturing Index, for instance, came in at -8.7 for June. That was down from -3.2 in May and below expectations for a reading of -2. The key "growth" subindex -- new orders -- fell to -5.5 from -0.5. But one "inflation" subindex (measuring prices paid) remained elevated (66.3 vs. 69.6 a month earlier), while another (measuring prices received) jumped to 26.7 from 15.2. That's the highest since January 2006 (27.4) and just below the all-time high (27.7 in January 2005).

Fourth, the list of executive casualties stemming from the credit crisis continues to lengthen. American International Group replaced its CEO Martin Sullivan with Robert Willumstad. AIG is the world's biggest insurer, and it has been losing billions of dollars in recent quarters as a result of the souring credit markets.

Fifth, real interest rates are deeply negative, and have been for the greater part of the past few years, if you use the federal funds rate and the year-over-year change in the CPI as your benchmarks. In fact, real rates are running at -2.2% (2% nominal FF rate - the 4.2% YOY change in CPI in May). Bloomberg picks up the torch this morning, reporting that real 10-year Treasury Note rates have also been negative for the longest stretch of time since 1980. An excerpt:

"The bear market for U.S. government bonds that began three months ago is just getting started.

"For the longest period since 1980, U.S. inflation has been higher than what investors earn on 10-year notes, a sign that yields have further to rise. Treasuries paid 2.88 percentage points more than the consumer price index the past two decades, according to data compiled by Bloomberg. Investors who buy $10 million of the securities would lose $1.4 million over the next year if the relationship returns to normal.

"The math doesn't pencil real well,'' said Thomas Atteberry, a partner at Los Angeles-based First Pacific Advisors, who recommended selling 10-year notes when yields fell to a five-year low in March. He co-manages the $2 billion New Income Fund, which beat 96 percent of its peers in the past five years, according to data compiled by Bloomberg.

"The combination of rising commodity prices, Federal Reserve Chairman Ben S. Bernanke's renewed focus on inflation and his success in reviving capital markets after the collapse of subprime mortgages has turned Treasuries into a quagmire. Investors who bought notes due February 2018 on March 17, just after the Fed helped arrange the bailout of Bear Stearns Cos., have lost 6.2 percent, according to Bloomberg data."

Chart of the freakin' day ...

You can see the original HERE.

Gazprom expects oil to hit $250 a Barrel "in the foreseeable future". And at the same time, Citigroup boosted its 2008 Brent outlook 22 percent to $116.60 a barrel, while Merrill Lynch raised its forecast by 14 percent to $114. The International Energy Agency lowered its estimate for non-OPEC output this year by 300,000 barrels a day to 50.04 million, in its monthly report today.

Saudi Arabia Calls for Summit on Energy Costs After a cabinet meeting led by King Abdullah, the Saudi government said, “the increase in prices isn’t justified in terms of market fundamentals,” according to a statement from the official Saudi Press Agency. No date was given for the energy summit.

XX Sean's note -- talk is cheap.

Bernanke Tries to Talk Up the Dollar, Vows Pigs Will Fly XX Okay, that's not the real headline on this Bloomberg story, but it might as well be. Bernanke also says on inflation, "Who you going to believe? Me or your lying eyes?" Or as Bloomberg puts it ...Federal Reserve Chairman Ben S. Bernanke said policy makers will "strongly resist'' any surge in inflation expectations, delivering his clearest message yet the central bank is done lowering interest rates.

Trade Gap in U.S. Widened in April to $60.9 Billion on Record Oil Imports The U.S. trade deficit widened in April as the surging cost of oil boosted imports to a record, overshadowing the biggest gain in exports in four years.

Corn Crop in U.S. May Shrink 10% as Midwest Rains Reduce Yields, USDA Says The U.S. corn harvest will be 10 percent smaller than a year ago as Midwest rains lower yields, the U.S. Department of Agriculture said. Inventories are projected to fall to a 13-year low.

Global Growth to Slow in 2008 on Higher Oil, Food Prices, World Bank Says Global economic growth will probably slow to 2.7 percent this year from 3.7 percent in 2007, checked by spiraling food and energy prices and the subprime credit crisis, the World Bank said.

Putting a face on "demand destruction." Senator Bernie Sanders collects stories of hardship caused by rising fuel costs and a downward economy. Some examples ...

• “We have at times had to choose between baby food and heating fuel.”
  
• “By February we ran out of wood and I burned my mother's dining room furniture.”
  
• “We also only eat two meals a day to conserve.”
  
• “My husband and I are very nervous about what will happen to us when we are old.”

Here is the IEA's latest Oil Market Report. And here is the EIA's International Petroleum Monthly. Some highlights of both ...

1. Global oil supply rebounded by 490 kb/d in May to average 86.6 mb/d, lifted by higher OPEC crude supply. The rise however comes after extensive downward revisions to 1Q08 non-OPEC production.
2. Global oil product demand is expected to average 86.8 mb/d in 2008, according to the IEA. So, you can see that supply already has trouble keeping up with demand.
3. According to the IEA, in April, oil production fell by a whopping 1.09 million barrels per day, not 400,000 barrels per day as they thought last month. That's because the IEA comes out with their estimate way before the vast majority of countries report their production. So they can do nothing but guess.
4. Non-OPEC production reached its current plateau in November of 2003, 4.5 years ago. In march non-OPEC production was 40.99 mb/d.
5. According to the EIA, World oil (crude and condensate) production in March was down by 134,000 barrels per day to 74,494,000 barrels per day. Production in January and February were revised downward.
6. March saw OPEC production drop 110,000 bp/d and non-OPEC production drop 24,000 bp/d.

Here's what I'm reading this morning. You might find these stories and blogs interesting, too.

Economics as science? No chance.
Economics is not a science. Physics wouldn't be a science either if esteemed members of that profession who got prestigious jobs running the country were willing to make statements that contradict all known facts.

Commodity Futures Speculation
Fundamentals are the most important part of the 5-year story, but that the falling dollar, negative real interest rates, and quite possibly fund purchases of commodity futures contracts have also made an important contribution during 2008.

The Economics of Sawdust
I was in Vermont over the weekend and talking to a dairy farmer about the rising price of milk. I was surprised when she said that higher sawdust prices was one of the causes.

xx Sean's note -- everything is interconnected, and in our modern society, even more so. I'm always wondering what shoe missing a nail is going to drop next. Speaking of which ...

More Collateral Damage from the Housing Crisis
The fallout of the housing crisis is affecting many more people than just those who purchased a home on dicey terms (or who provided the loan, or now owns the debt). In several posts we will highlight how the current crash has been cause for concern in some unexpected places.

Austrian Finance Minister Proposes European Tax on Commodity Speculation Austrian Finance Minister Wilhelm Molterer said he'll propose a Europe-wide tax on commodities speculation as people across the continent protest against higher fuel and food prices.

Oil Trades Little Changed as Asian Governments Attempt to Cool Consumption Crude oil was little changed as Malaysia scrapped fuel price controls and India said subsidies were becoming unsustainable.

Corn Falls After U.S. Crop Conditions as Expected; Wheat Futures Decline Corn futures declined in Chicago for the first time in three days as a government report on the state of the U.S. crop, the world's biggest, was within market expectations. Soybeans rose for a third day, while wheat fell.

Nifty Oil Clock
Want to see how much oil the world uses second by second? CLICK HERE.

COMMODITIES

Bank Commodity Derivatives Rise to $9 Trillion, 1.5% of Total Outstanding Commodities derivatives held by banks expanded 27 percent last year to $9 trillion as declining raw- material supplies and lower interest rates buoyed investor demand, according to International Financial Services London.

Institutions Money Drives up Commodities

In the last five years, investment in index funds tied to commodities has grown from $13 billion to $260 billion, and the price of the 25 commodities that compose those indices have jumped 183 percent, according to congressional testimony from Michael Masters, managing member of the Virgin Islands-based hedge fund Masters Capital Management.

Rio Tinto says demand will surge through 2022

Rio Tinto and Joy Global both gave bullish prospects for the mining industry, saying they stand to benefit from ravenous demand from China, India and elsewhere.

Rio Tinto, Big Coal Won't Spend Billions to End Climate-Changing Pollution Rio Tinto Group and U.S. utilities are urging the government to spend $20 billion on a technology they say has the best chance for eliminating pollution linked to global warming.

India Rules Out Higher Oil Subsidies, Signaling Gasoline Prices May Rise India's Prime Minister Manmohan Singh said subsidies can't be allowed to rise any further, indicating his government may increase fuel prices capped since February.

Sinopec to halt oil products exports
"Sinopec will raise production, halt exports and adjust product structure to ensure domestic supply, especially for the reconstruction after the earthquake, the summer harvest and the Olympic Games," said Sinopec President Wang Tianpu.

Australian quarterly gold output plunges to lowest level in 19 years
At 53 tonnes, Australia's first-quarter gold production showed a 16% drop on the previous quarter's figure, and was 12% lower year-on-year.

AGRICULTURE

Soybeans Fall as Argentine Farmers to Decide on Tax Protests; Corn Slides Soybean futures fell in Chicago as Argentine farmers are poised to decide whether to extend more than two months of protests against higher agricultural export taxes. Corn fell and wheat extended gains.

Corn, Soybeans May Rise as Rains Threaten to Harm U.S. Crops, Delay Sowing Corn and soybeans may rise on speculation rains this week will flood Midwest fields, delaying seeding of the two biggest U.S. crops or harming young plants.

ECONOMIES AND CURRENCIES

Russian 2008 Inflation May Accelerate to 14%, Threatening Growth, IMF Says Russian inflation may accelerate to 14 percent this year and the risk of the economy overheating is mounting, an International Monetary Fund official said.

Paulson Says Financial-Market Turmoil Will Last `Months,' Supports Dollar U.S. Treasury Secretary Henry Paulson said it will take ``months'' before financial-market turmoil ends and that he ``very strongly'' supports a strong dollar.

CHINA

Brilliance China Gains Most in Eight Months on Introduction of New Model Brilliance China Automotive Holdings Ltd., the local partner of Bayerische Motoren Werke AG, rose the most in eight months in Hong Kong trading on expectations a new model would boost earnings.

XX Note -- subscribers to my Asia report from last year will remember Brilliance Austomotive as one of the picks.

The dollar continues to rally just as we were warming to the idea of a new low—and so it goes.  What’s the driver?  Maybe the decline in gold coupled with a small pull-back in crude (see reader chart next page)?  But because they have been correlated, it is tough to say one or the other is the driver.

The new theme seems to be higher US interest rates (the better than expected durable goods report yesterday has helped validate this view).  The Fed may actually hike rates before the end of the year, was mentioned in the lead story in the Financial Times today; that would represent a major shift in expectations.

Forecasting a Fed rate hike we are not so sure.  But we’ve seen a decent move down in US 10-year notes lately i.e. higher rates.  And 10-year notes have been yet another price series moving in tandem with the US$ index.  Below a chart of 10-year note futures vs. US$ Index Inverted (red line):

The other day, one of our readers (thank you Mihaly) shared an interesting chart with us; we thought you might have an interest.  It is a weekly chart of crude oil showing that two of the major legs are similar in distance travelled.  We have recreated the chart below:

Black Swan Capital

We hear from Bloomberg that both the United Arab Emirates and Qatar could abandon their currency pegs to the U.S. dollar in favor of a basket of currencies within months, and Saudi Arabia may follow the move late next year. They would all be following the lead of Kuwait, which last year broke from its neighbors and fixed its dinar to a basket of currencies.

Why are the Gulf States doing this? Thanks to surging energy prices, Gulf nations are experiencing an unprecedented boom, and an increasing inflation problem. Yet their currencies are depreciating and their central banks are under pressure to cut their nominal interest rates to match the Fed.

Plainly, the US Fed's easy money policy does not work for them. Even though many investors believe the US interest rate easing cycle is at an end -- futures on the Chicago Board of Trade showed traders saw a 92% likelihood the Fed will keep its target rate for overnight lending between banks at 2% on June 25, up from odds of 88% on May 21 -- it's too little, too late for the Gulf states.

What's more, Forbes quotes Deutsche Bank and others as saying that the Fed may NOT be through cutting rates, and may drop the benchmark from an already low 2%.

Continued cuts in the Fed benchmark rate could grease an already slippery slope for the US dollar. Since the Fed cut rates from 5.25% to 2% since last August, wholesale inflation has increased to 6.5% year over year and the price of oil has soared to over $130 from $70. A global supply/demand squeeze for distillates like diesel gets much of the credit, but the meteoric rise in oil prices wouldn't have happened without the Fed's help. If the value of the US dollar had just held steady since August, the price of oil would be under $90 a barrel.

And as bad as inflation is, it's probably much worse than the government admits. ShadowStats.com is a website that tracks the Consumer Price Index the same way it was before the Clinton administration started monkeying around with it. And according to ShadowStats, consumer price inflation is running at more than 3 full percentage points hotter than the government says. Would the government lie to you? Hahahahaha!

And this is my long-winded way of getting to my subject: Gold and silver prices. It seems that foreign governments, especially those in the Persian Gulf, are losing their faith in the almighty dollar and the policies of the US government. That undercuts the mighty greenback's standing as the world reserve currency. Now, that doesn't mean your dollars become worthless overnight. But the more its reputation gets chipped away, the faster its downward slide can become. I think this has the potential to heat up the fires under gold and silver quite a bit.

If paper money becomes devalued, people will put more faith in hard currencies. More and more Moms and Pops put a few gold and silver coins away "just in case," and the trickle we see in gold and silver coin investing now can become a flood. And thus we learn from the Wall Street Journal that demand is simply overwhelming the supply of US Silver Eagles. Why are so many "early movers" suddenly buying silver coins. What are they afraid of?

As the old saying goes, if you have to ask that question, you haven't been paying attention.

The Wall Street Journal covers the aggressive, renewed use of incentives by new home builders. An excerpt:

"Highlighting their desperation to sell houses, builders are bringing back the gimmicks -- mortgage rates that start low, help with down payments, zero out-of-pocket expenses -- that helped fuel the housing bubble before it went bust.

"But this time, they say, history won't repeat itself.

"This weekend, Lennar Corp., the nation's largest builder by revenue, will start interest rates at 2.88% for the first year -- 3.88% for the second -- before a slightly higher rate locks "for life." In some markets, Ryland Group Inc. will cover the down payment and closing costs, while KB Home has zero-down deals. Hovnanian Enterprises Inc., meanwhile, also is helping buyers secure down payments, and its mortgage subsidiary eliminated loan closing fees.

"Builders, trying to survive the worst downturn since the Depression, must move inventory quickly to bring in cash: Stung by eroding land and house values that show no sign of stabilizing, the nation's top builders have racked up more than $24 billion in impairment charges, according to Standard & Poor's.

"Builders acknowledge things are tough, but they promise they are being responsible: To keep people out of houses they can't afford, they are scrutinizing income and credit scores and making sure loans don't reset with unbearable payments."

I would argue that the incentives never really went away. I've seen builders continue to offer all kinds of sweeteners to drive traffic. It's worth noting that the fine print (and sometimes, the big print) in advertisements has shifted. Many offers are dependent on the ability of the borrower to obtain FHA financing, rather than private mortgages. Some deals assume the involvement of down payment assistance programs, which are somewhat controversial in their own right.

For example, here is the disclaimer language from an offer being touted in my neck of the woods:

"$0 down offer assumes buyer will qualify to obtain down payment from a non-profit down payment assistance program. Funds to cover closing costs paid by seller as defined on your good faith estimate, are subject to seller contribution limits and do not include prepaids. Offers, incentives and seller contributions are subject to certain terms, conditions and restrictions and are available only to qualified buyers financing through Universal American Mortgage Company and closing with designated closing agents. Lennar reserves the right to change or withdraw any offer at any time. $0 down/$0 closing costs offer is only good on inventory homes that sell and close by 5/30/08 and can only be used with FHA loans."

A monthly Energy Department report said demand for finished petroleum products dropped 8.5% in February from January -- to 573,677 million barrels from 623,545 million barrels -- and demand for gasoline fell by 6.2%, to 256,422 million barrels from 273,235 million barrels in January.

News articles have said (and I'm quoting from one): "Though some of that drop can be attributed to February's being a shorter month, it still suggests high prices are cutting American's appetite for fuel."

Let's do the math ...

January -- 273,235 divided by 31 days = 8.81 million barrels per day

February -- 256,422 divided by 29 days* = 8.84 million barrels per day.

*29 days this past February, which was a Leap Year.

Indeed, it seems that per-day gasoline usage increased (slightly) from January to February. With the margin of error, demand was basically unchanged.

You wouldn't believe how many media people I've talked to in the last two days who have been bamboozled by this.

On the other hand, traders fell for the government's BS too, so they shouldn't feel bad.

Here's a chart for you...

In other news ...

CURRENCIES

Dollar Heads for Monthly Gain Versus Euro on View Federal Reserve to Pause The dollar is set for its first monthly advance against the euro this year on speculation a cut in interest rates by the Federal Reserve today will be followed by comments signalling policy makers are about done with easing.

AGRICULTURE

K+S Shows How Widening Food Shortage Means Potash Shares Can't Find Peak Two days after Barron's magazine sent shares of potash makers lower with a March 18 article predicting a sell-off, India's largest importer agreed to more than double the price it pays for the fertilizer.

Corn Futures Rise in Chicago, Head for Eighth Monthly Advance; Soybeans Up Corn prices in Chicago rose, heading for an eighth straight monthly gain on speculation U.S. farmers will plant less in favor of other more profitable crops. Soybeans advanced for the first time in six days and wheat was also higher.

GOLD

Gold Falls to Three-Month Low in London Trading as Investors Sell Metal Gold fell to a three-month low in London on signs that investors are selling metal held through exchange-traded funds. Platinum and silver also dropped.

We’ve been dogging on the pound for a series of months now. And for the most part, we expect to be dogging on it for months to come. Basically, weak economic data points are going to weigh on Bank of England and their interest rate policies. That, in turn, should undermine the pound. But ...

We could be on the brink of a major (or somewhat major) turn in the euro. Fresh off highs versus the dollar, pound, and yen, the euro is in need of a major cool down. If the cards fall right, this euro swing could come very soon.

So if you’re looking for a way to get in against the euro, but you’re too skeptical of a dollar recovery, then maybe you look to the British pound.

 

We’ve got one word to describe the above chart of the euro versus the pound: nosebleed. If investors become legitimately concerned with the outlook for the euro, the British pound could easily make good on the shockwaves.

This pair has run awfully high in the last nine or ten months. It looks as though there’s plenty of room remaining for a reasonable correction. The 7600-level appears to mark the spot.

Sorry for the lack of posts today -- been pretty busy. One thing that I couldn't help comment on, however: Have you noticed that mortgage rates have been ticking higher lately? And that this has had an impact on purchase applications?

The Mortgage Bankers Association's weekly purchase application index dropped 6.4% to 357.30 in the week of April 18. This index has only been lower once this year -- 356 in the week of March 28. The MBA also said its measure of 30-year fixed-rate loan rates popped back above 6% (6.04%) for the first time since the beginning of March.

Now I don't want to make too big a deal out of this. But if we were to break down out of the recent range in purchases (let's say, below 350) and/or break out to the upside in interest rates (let's call it above 4% in the 10-year Treasury note yield, or 6.4% on 30-year mortgages), it'll be something to pay attention to.

The culprit for this recent upside move appears to be inflation fears, spurred by record-high commodity prices, and the flight of money out of bonds and into stocks, spurred by greater risk-taking behavior on the part of investors.

Fed Takes Broad Action to Avert Financial Crisis
The Federal Reserve took dramatic action on multiple fronts last night to avert a crisis of the global financial system, backing the acquisition of wounded investment firm Bear Stearns and increasing the flow of money to other banks squeezed for credit.

XX This Washington Post story reads like a freaking financial horror story -- the kind of thing Wall Street bankers tell their children to give them goosebumps. And it's happening now! Check out some of these lines ...

1. The Fed's moves were meant to reverse a rising tide of panic...
2. The extraordinary measures were made necessary, in the view of the policymakers, by the most dire threat facing world financial markets in years....
3. It took 85 years to build Bear Stearns and four days for it to dissolve....
4. Starting today, and lasting for at least six months, this new operation will allow "primary dealers," which are 20 major Wall Street firms, access to cash in exchange for assets in which the market is not currently functioning.

XX P.S. The Fed also approved a cut in its benchmark interest rate to 3.25 percent from 3.50 percent. The Washington Post now calls this the Fed's "emergency lending rate".

Today is Central Bank Day! And tomorrow is Jobs Day! Wa-hoo. Can you sense my sarcasm?

Basically, over the next two days we can expect FX traders to be jumping in and out of the market like a bunch of six-year-olds hanging around a swimming pool. The Bank of England, the European Central Bank, U.S. jobless claims, and U.S. pending homes sales should provide for volatile markets today; and the U.S. Non-farm Payrolls will be more than enough to make investors go crazy tomorrow.

Those of you with well-reasoned positions should be prepared to get splashed.

The Bank of England already announced their decision to stay put on interest rates. Apparently inflation is a concern again. Unlike the Federal Reserve, the Bank of England is taking a bilateral approach with monetary policy – acknowledging both growth and inflation. The pound is making good immediately following the announcement.

As we work the rest of the way through this gauntlet of monetary and economic reports, the euro is trading at record-highs versus the buck. And there aren’t a whole lot of reasons for it not to. A story on Bloomberg.com this morning highlighted the expectations for the Euro area economy to expand at a faster pace than the U.S. economy this year.

To that I say okay, but everyone knows just how badly the U.S. economy is faring these days. How impressive is it for a major industrialized economy to outpace the U.S. at a time like this? The actual figures cited in the article sure weren’t that impressive. U.S. GDP is set to decline to 1.5% from 2.2% last year. Euro area GDP is set to decline to 1.6% from 2.6% last year.

Do expectations like that warrant and exchange rate of 1.53 euro per dollar? I’d have to lean towards no. But hey, it’s the market that makes the call.

I just wonder if things in the euro area could get any worse. After all, the U.S. doesn’t have a whole lot of room still to tumble. The euro area still could. And more importantly, traders and investors could be caught off guard if the Euro area starts on a more noticeable slide, no matter how orderly the decline.

One structural dynamic that has the potential to shift – demand from foreign countries for European capital goods (Carlos Caceres and Eric Chaney over at Morgan Stanley Global Economic Forum highlighted this point last month.) Thus far demand of this sort, from emerging economies in particular, remains solid. But you have to wonder when the exchange rate will come into play.

My guess is fairly soon. And the faster the market bids up the value of the euro, the sooner we’ll see an overvalued exchange rate negatively impact the European economic backdrop. And then maybe the market thinks twice about 1.60 euro per dollar. Maybe.

 

The ECB will most likely stay put on interest rates as well. But there’s no telling where these currencies might finish when the day ends. Good luck navigating these markets today and tomorrow.

I don't worry (too much) about the subprime credit crisis at Merrill Lynch, Goldman Sachs and others. Sure, it could total $600 billion, but these are smart people who will figure a way out of the the problem they created. If they don't, these companies will go bankrupt. Life will go on.

But the crisis in the municipal bond market is scaring the bejeezus out of me. Let's look at this mess.

As Forbes explains ...

Municipal bond insurance got its start as a way to protect investors if their bond issuer defaulted. After starting in 1971 ... The invention of municipal bond insurance revolutionized the public debt markets over the next 36 years.

The U.S. municipal bond market grew steadily over several decades to about $2.6 trillion in value as of year-end 2007, according to the Securities Industry and Financial Markets Association (SIFMA).

$2.6 trillion is about as much as the US will spend on the Iraq War. It's a heck of a lot of money. But this is basically how states and cities function now. They issue debt for projects at very low interest rates because the bonds are insured. But that insurance may turn out to be a mirage, or at least, it may no longer be available.

Bloomberg explains ...

Yields on top-rated 30-year bonds rose to 4.99 percent today, the highest in almost four years, as U.S. state and local governments plan to sell $20 billion of new bonds in the next 30 days, the most since December.

The biggest buyers of variable-rate notes, tax-exempt money-market mutual funds, are avoiding issues backed by insurers and local governments whose own rating is less than AA, said Joe Lynagh, who manages about $2 billion of tax-exempt money funds.

New York state paid rates ranging from 2.80 percent to 10.94 percent on seven-day variable-rate demand notes sold Feb. 27, the most recent data available. Bankers set interest rates of 5 percent or higher on six of the 18 issues sold that day.

Now, the market is actually seizing up.

Reuters explains ...

Two of these markets, auction rate and variable demand note obligations, have frozen because investors fear some bond insurers that backed this debt are no longer credit-worthy as a result of their bad bets on subprime mortgage investments.

This couldn't come at a worse time for municipalities. Their tax revenues are drying up due to the implosion of the housing market. Suddenly, it turns out that many municipalities may not be able to make good on their debt payments.

And that brings us to the next logical step -- municipal bankruptcy.

As the LA Times blog explains ...

The city council of Vallejo, Calif., had planned to vote late Thursday on whether to file for bankruptcy protection because its employee-benefit costs are soaring even as tax revenue declines. The vote was put off after officials said they had reached a tentative deal with their major unions.

Is the problem snowballing? In a word, "yes."

Even high-quality muni issuers that have no credit problems may pay more if they borrow soon, simply because of the heavy supply of bonds expected to hit the market.

This is absolutely the worst time to bring debt to market. Naturally, states and cities aren't changing their plans at all ...

In Sacramento, state Treasurer Bill Lockyer intends to proceed with next week's planned sale of general obligation debt, said Paul Rosenstiel, head of public finance.

Although the state may have to pay higher yields on the bonds than it would like, "we have a need to get into the market because we have a lot of projects to build," Rosenstiel said, noting the numerous infrastructure programs approved by voters in recent years.

"We have a schedule, and we're probably going to stick with it," he said.

And now Bloomberg explores the crisis of cities forced into loans with "predatory yields" ...

U.S. municipal borrowers from Camden, New Jersey, to Sacramento, California, might face a third week of higher interest costs as failures in the auction- rate bond market persist.

How bad will the crisis get? On Minyanville, Professor Bennet Sedacca takes a guess ...

Net asset values of all sorts of municipal mutual funds, both closed end and open end will likely get smashed. How badly? It depends on the quality but I am guessing anywhere from 5-20%.

Forbes says the municipal bond market is worth$2.6 trillion, but Sedacca's estimate is closer to $3.5 trillion. 20% of $3.5 trillion would be $700 billion. And as with all of these credit crisis estimates, they usually go much higher.